Think two steps ahead to keep your international deals afloat

You’re excited about that joint venture deal you signed with an overseas company. Together you’ll build a factory that will take orders from both sides, with the other company operating the factory. Excited, that is, until profits mysteriously vanish. You start to suspect the overseas firm is diverting orders to another factory—that it secretly owns. Now imagine your JV partner is owned by a politically influential businessman and the case must be litigated in a court in the other country. Do you think your company will get a fair shake?

Doing business in a foreign land can be daunting enough. But if and when something goes wrong, executives face the prospect of foreign legal systems, foreign business ethics, and foreign-language key documents. About a third of international business deals result in some sort of dispute, estimates Cedric Chao, based on his 30 years of international litigation experience. The additional level of complexity involved in managing and settling cross-border disputes can doom any deal—or make you wish you hadn’t gone overseas in the first place.

Fortunately, signing an agreement with a Guangdong supplier does not fate you to a Guangzhou court date, notes Chao, who, as co-chair of Morrison & Foerster’s International Litigation and Arbitration Practice, has handled cases similar to the one described above. There are many alternatives for dispute resolution, though none is a silver bullet. Your success in resolving the frictions that arise will depend largely on how you set the ground rules for dispute resolution in those halcyon days when the deal is still being negotiated and everyone is hoping for the best.

The Rise—and Fall—of Arbitration

Arbitration has gained favor as the ticket out of that Chinese (or Indian, or Hungarian) courtroom. “Some might say this is a golden age for arbitration, and that’s been driven by globalization,” says Alan Owens, an international litigator with Morrison & Foerster in London. A clause calling for arbitration in case of disputes has become commonplace in complex commercial contracts, he adds.

The appeal of arbitration in cross-border deals is clear. Arbitration provides a neutral forum that is less likely to favor either party; arbitration can occur anywhere and involve participants from any country; parties can choose their arbitrators, who have technical and industry-specific expertise; and arbitration is generally confidential, so the parties avoid negative public exposure.

Most important, arbitral awards enjoy greater international recognition than judgments of national courts. When it comes time to seize assets, freeze bank accounts, or seize commercial property to enforce a ruling, many courts will not honor foreign judges’ orders. But 144 countries have signed the U.N. convention that effectively requires judges to honor arbitral awards.

An arbitration clause can have a powerful effect on a business deal, whether or not arbitration ever occurs, says Craig Celniker, the Tokyo-based co-chair of Morrison & Foerster’s Commercial Litigation and International Arbitration Groups. Think of a deal in which a party—say, a Chinese company—is convinced that any legal hearing is likely to favor it simply because the hearing will be in a Chinese court.

If a dispute arises, “the side that thinks it has the advantage will be intransigent, and the value of the deal will be slowly bled away, because you don’t want to fight in a Chinese court,” Celniker says. “But you’ll have a much stronger backbone if you know that your dispute will go to three English lawyers in a Hong Kong arbitration center.”

Nonetheless, arbitration has suffered a backlash in recent years, as critics contend it no longer deserves its reputation as a faster, cheaper, and more efficient alternative to litigation. “Arbitrators largely now have the power to grant final rulings on disputes, with little intervention from the courts,” notes Owens. “But that puts pressure on them, and other members of the community, to ensure that they get the right answers. So the process expands and expands.” Arbitrations have become more formalized, with drawn-out discovery processes and pre-hearing motions similar to those seen in American courts.

This so-called “Americanization” of international arbitration is due, in part, to the growing presence of Americans as both parties and arbitrators. International arbitration has its roots in European civil law. As a result, both European commercial legal cases and traditional arbitration have very limited document discovery, no depositions, and witness testimony submitted in writing. Some Americans feel the process isn’t nearly thorough enough. (People from other common-law countries such as England, Canada, and Australia may share this view.) To them, arbitration “may be very speedy and efficient, but it does not feel like justice,” says Chao. And arbitration rulings rarely allow room for appeal.

These concerns about the arbitral process have only grown as the nature of cases that go before arbitration has changed, Chao says. These deals have grown in size and complexity, raising the stakes in any given case. And more deals are being struck in developing nations, some of which have a reputation for rough-and-tumble business practices. Some Western executives question whether arbitration’s genteel approach can make much headway when egregious misconduct is suspected—as in the joint venture case described earlier.

Fire with Fire

Arbitration administration organizations are fighting the Americanization trend with tools borrowed from America. “They’re borrowing from the best practices of the American judiciary with respect to those jurisdictions that are seeking to manage complex cases in an expeditious manner,” says James Schurz, co-chair of Morrison & Foerster’s Commercial Litigation Group in San Francisco. Several organizations have recently changed their guidelines. The Paris-based International Chamber of Commerce’s Court of Arbitration—one of the world’s most prestigious and popular arbitral bodies—made several changes that took effect this year:

• Companies can apply for an “emergency arbitrator” who can make a rapid decision, akin to the injunctive relief provided by courts.
• Arbitrators must convene a case management conference to dispose with scheduling and procedural matters.
• Arbitrators can force a party to pay for a greater share of costs if they find that it didn’t conduct the arbitration in an “expeditious and cost-effective manner.”

These new rules are having a significant effect on ICC arbitrations, Schurz says. At the same time, a variety of reforms are permeating the world of international arbitrations, constituting what he calls “Commercial Arbitration 2.0”:

• Parties are starting to favor arbitrators with strong managerial skills who will push the schedule aggressively and resolve thorny issues in preliminary conference.
• Witnesses are testifying via videoconference (subject to various countries’ rules governing the taking of testimony).
• Arbitrators are ordering expert witnesses from each side to confer under oath to reach agreement where possible.

The ICC and other arbitral bodies—like American courts—are also struggling with how to deal with the flood of material created by email discovery requests.

More arbitration agreements are adopting the International Bar Association’s Rules of Evidence, which allow parties to make narrowly tailored and carefully justified requests for specific kinds of documents. Those rules steer a path between traditional arbitration—which only allows documents voluntarily disclosed by each side— and American commercial litigation, in which judges may allow vague discovery requests that leave lawyers struggling with a roomful of documents.

“Commercial arbitration is entering an exciting new era” thanks to recent reforms, Schurz says. “We can expect our arbitrations to go faster, with hearings generally completed within one year of filing the demand.”

Step by Step

Arbitration is not the only option for international dispute resolution. Litigation in national dispute resolution. Litigation in national courts is still an option, as is mediation. Like arbitration, mediation is sometimes overseen by technical experts, and the results are confidential. But “a knowledgeable mediator may be able to help the parties identify creative ways to resolve disputes,” says Sherman Kahn, Of Counsel with Morrison & Foerster in New York. Mediators are trained to help the parties identify mutually beneficial tradeoffs and to “adopt changes in governance of the relationship that will reduce the chances of future misunderstanding,” he adds.

Ultimately, all of these dispute-resolution methods are complementary. More cross-border deals now feature a “stepped” or “staged” dispute-resolution clause dictating an escalating sequence of increasingly formal and binding procedures. In a typical clause of this type, the first step will be a negotiation between senior executives; the second, a mediation; the third, arbitration. Each step must occur within 30 to 90 days.

The early negotiation phase can mandate an information exchange between the parties, Schurz says. Some dispute-resolution clauses include an agreement to a third-party audit. For example, if a company takes issue with its partner’s royalty payment, the auditor can review the partner’s books to verify their accuracy.

Given that legal issues are often framed during early negotiations, it can be useful to get attorneys involved in a dispute even before it formally enters arbitration or litigation, says Louise Stoupe, a Tokyo-based Morrison & Foerster partner. For example, Stoupe understands that Japanese parties often use different tactics and have different expectations for negotiations than Westerners.

Pick Your Spots

The ground rules established by the dispute-resolution clause can have a big influence on the result. A key issue to anticipate is whether your company is likely to be the one making a complaint or responding to one. (Though there are no hard-and-fast rules, a technology licensor, joint venture minority investor, or outsourcing customer may be more likely to have a complaint, while a licensee, JV local partner, or outsourcing provider may be more likely to be on the responding side.) The complainant will tend to favor procedures that give them greater access to relevant documents and testimony, while the respondent—which will have to respond to a burdensome request—may resist them. Similarly, the complainant usually prefers fewer financial or procedural hurdles to escalating a dispute into arbitration or litigation, notes Stoupe.

International parties face a number of other important decisions at the outset of a deal—among them the governing law that will apply to the contract, the arbitral organization to be used, and the country where the arbitration will occur. Companies need to think ahead about whether their position is strengthened or weakened by the rules established by the governing law, or forum or locale, says Chao. But regardless of which side you’re on, you’ll want to settle on an arbitral locale with a pool of arbitrators experienced in complex cases, Celniker says. You’ll also want a country where judges are familiar with arbitration and are not susceptible to undue influence. Those judges will honor the arbitral process and smoothly handle the issues that occasionally emerge from arbitration. In Asia, for example, Celniker prefers the arbitration centers in Hong Kong and Singapore to those in Japan, Malaysia, mainland China, and elsewhere.

(And how could these ground rules have impacted the joint venture dispute described at the beginning of this article? If the American company had negotiated for the imposition of an audit or for broad discovery rules in the dispute-resolution clause, it might have uncovered or even prevented egregious misconduct. If the overseas company was potentially stealing trade secrets, Chao says, officials in that country might have been persuaded to raid the factory for evidence of the theft.)

The arbitration process is extremely flexible, and parties have tremendous leeway to negotiate their own rules. Executives would be wise to think carefully about those rules before signing off on any deal. The dispute-resolution clause is often called the “midnight clause” because it is often inserted at the last minute in negotiations. Executives with visions of a profitable union dancing in their heads may be as excited about the dispute clause as lovebirds would be considering a prenuptial agreement. But given the frequency of business disputes, it’s worth giving some extra consideration before breaking out the champagne.