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Arbitration under unilateral documents: how to avoid enforcement risk

The problem in a nutshell: consent

Documents executed by only one party in favour of a non-signatory are commonplace in commercial transactions, for example in the financial services and construction sectors where guarantees and bonds are often issued in this way. However, when parties are trying to resolve disputes arising under what are, for convenience, referred to as “unilateral documents” in this blog, they may encounter a number of legal hurdles.

Arbitration is based on the consent of all parties to arbitrate rather than to resolve their disputes in the local courts. Given the important nature of this agreement, it is generally required to be “in writing”. The English Arbitration Act 1996 defines “in writing” relatively widely, accepting that agreements to arbitrate may be “evidenced” in writing or even be non-written agreements referring to written terms. An arbitration agreement in a unilateral document is therefore generally seen as enforceable under English law.

Other jurisdictions, however, follow more closely the stricter requirement in the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958. Under the New York Convention, an “‘agreement in writing’ shall include… an arbitration agreement, signed by the parties or contained in an exchange of letters…”. This is generally seen as requiring all parties to execute the arbitration agreement.

Where the arbitration clause provides for an arbitral seat in one of these foreign jurisdictions, or where the seat is in England but enforcement of an award may take place abroad, there is a risk that a foreign court will refuse enforcement of any award issued pursuant to an arbitration clause in a unilateral document.

While the New York Convention generally allows parties to enforce arbitral awards in most countries worldwide, enforcement may be refused by local courts on the ground that the award is contrary to the jurisdiction’s public policy by virtue of a lack of consent to arbitrate.

To avoid this enforcement risk from the outset, this blog sets out practical solutions to ensure that arbitral awards will be enforceable, thus avoiding incurring time and expense resulting in an unenforceable award.

Unilateral documents in commercial practice

A number of common commercial transactions involve the use of unilateral documents, and often these will contain arbitration clauses, especially when this is consistent with the remainder of the transaction documents. Where the unilateral document is subject to English law, it is most commonly executed in the form of a deed poll, which is a deed signed by one party in favour of another party.

Such unilateral documents are used, for example, in the following scenarios:

  • Company A contracts with foreign company B and requests a guarantee from B’s parent company C which is incorporated in A’s jurisdiction.
  • Contractor A subcontracts works in relation to its construction project to subcontractor B; the subcontract may envisage B obtaining a performance or on-demand bond from its bank C as security in favour of A.
  • Company A novates or assigns its contract with B to its subsidiary C which is a project company without significant assets; A may issue a guarantee in favour of B in order to give B confidence that it will receive what it is promised under the contract, even where C defaults.

None of these guarantees or bonds is necessarily signed unilaterally; in many instances parties opt for “traditional” execution by two or more parties. Where parties opt for unilateral execution, this can be for a number of reasons: in some cases, it is simply faster and more convenient to execute the document unilaterally rather than to send a physical copy to the counterparty. In other cases, tax or regulatory reasons prevent the party receiving the bond or guarantee from signing the document; this can be particularly relevant where the parties are not based in the same jurisdiction. A further situation where parties tend to sign documents unilaterally is where a benefit is conferred upon a large number of counterparties, or a varying class of counterparties (for example, employees, bondholders or shareholders in a publicly traded company); in such cases, it would be impractical to arrange for signature by every member of the class and to obtain further signatures whenever an individual joins the “class” of individuals identified.

Solutions in practice: making it clear from the outset

The remainder of this blog will be dedicated to pointing out various practical drafting tips by which parties can ensure their dispute resolution clauses are as consistent and effective as possible.

Unilateral documents often fulfil ancillary functions in larger commercial transactions, or guarantee the obligations in a main contract. In most (but not all) cases, the subject matter of the unilateral document and the other, related contracts overlaps. This makes it desirable to provide for the same dispute resolution mechanism in all contracts, whether arbitration or court litigation.

Practitioners may face a scenario where a party is about to execute a unilateral document containing an arbitration clause and the other party’s assets are in a jurisdiction where the enforceability of arbitration clauses in unilateral documents is in question, due to the lack of written consent to arbitrate. How can practitioners seek to ensure that the parties’ choice of arbitration will be respected?

Is unilateral execution really necessary?

Where the use of unilateral documents results in an enforcement risk, the obvious solution is to avoid their use altogether. By making the party in whose favour the bond or guarantee is to be executed a signatory, concerns about the parties’ consent to arbitrate fall away. However, this may not always be an option, for example, where signature by all parties is not possible within the available timeframe, or for tax or regulatory reasons. Where a guarantee is issued in favour of a varying class of shareholders or employees, it may also not be practical to make all beneficiaries signatories to the agreement.

Is an umbrella agreement an option?

Where unilateral execution of a document cannot be avoided, a preferred dispute resolution option in complex commercial transactions is for all parties to enter a so-called umbrella agreement.

The most common approach is to include mirror image arbitration clauses in each transaction document, ensuring (through complex and bulky drafting) that disputes under different contracts can be consolidated and that transaction parties can be joined to arbitrations even where they are non-parties for the purposes of the relevant arbitration agreement. An umbrella agreement, instead, is a separate agreement between all parties involved in the transaction (including the issuer of the unilateral document), providing for a consistent dispute resolution mechanism for all disputes arising under any of the transaction documents.

The arbitration clause in a unilateral document will be replaced with a short clause incorporating the umbrella agreement’s dispute resolution provision by reference. Under English law, express and clear language is required to do so. In this way, the arbitration agreement incorporated into the unilateral document is an arbitration agreement signed by all relevant parties, and thereby complying with the formality requirements set out in the New York Convention and any corresponding local law.

While this is a clean solution in theory, it can be difficult to implement in practice. For example, it is possible that some of the transaction documents will have already been signed by the time the parties are drafting or negotiating the guarantee or bond. In that case, an umbrella agreement may no longer be practical. There may also be significant reluctance from some parties to enter into what is perceived as another legal document produced at further cost in the context of an already complex commercial transaction with various inter-related contracts.

Before entering an umbrella agreement, local law advice should also be sought in the jurisdiction where any award may need to be enforced to ensure that the umbrella agreement (and awards made pursuant to such agreements) are enforceable in that jurisdiction.

Umbrella-“light”: can an arbitration agreement in another contract cover the unilateral document?

Where the party executing the unilateral document and the party in whose favour the unilateral document is issued are both parties to another transaction document, a further solution is to amend the drafting of the arbitration clause in that bilateral or multilateral contract to effectively become a kind of umbrella agreement covering the unilateral document.

In practice, this can be achieved by drafting the arbitration clause in the multilateral contract so as to refer to disputes arising under the multilateral contract, as well as under the unilateral document. Care should be taken that all references in the arbitration clause are amended accordingly, including any joinder and consolidation provisions. In return, the arbitration clause in the unilateral document will be replaced with wording incorporating by reference the arbitration clause from the multilateral contract.

This option can be preferred in some cases. It dispenses with the need for an additional document while also reducing any enforcement risk. This option will not be available in practice, however, where the unilateral document is the issuing party’s only involvement in the transaction. This is the case, for example, where a bank issues a bond in favour of a construction contractor.

Dealing with risk: what to do when a dispute has arisen?

Where a dispute arises under a unilateral document and the above options were either not available or not used, parties should seek advice in relation to the risk of proceeding to resolve the dispute by arbitration. In particular, local law advice from the jurisdiction where enforcement would likely be sought can shed light on how significant the enforcement risk will be in the particular factual scenario.

Another relevant factor will be which party is contemplating bringing a claim under the arbitration clause contained in the unilateral document. Where the non-signatory party is commencing the arbitration, the enforcement risk may be lower, because the argument that there was a lack of consent to arbitrate will be less convincing. Indeed, commencement of the arbitration by the non-signatory party could likely indicate that consent. If, however, the issuer of the bond or guarantee is bringing the claim, the enforcement risk will tend to be higher. In this case, the non-signatory party might bring a jurisdictional challenge. Even if this was to fail, the challenge could be relied upon at the enforcement stage as evidence indicating that there was no consent to arbitrate. If the resisting party chooses not to participate in the arbitration, this might lend further weight to any application resisting enforcement in foreign courts at a later stage.

A practical solution to avoid legal uncertainty would be for both the non-signatory and the signatory party to enter into a written agreement to submit their dispute to arbitration after it has arisen. This should significantly reduce the enforcement risk, as the enforcing party will be able to point to an arbitration agreement which satisfies the formality requirements set out in the New York Convention and, as a consequence, of any local law.

In practice, however, where a dispute has arisen, parties tend to be reluctant to agree even on basic points. Any party which contemplates that an arbitral tribunal may issue an award which is not in its favour may be unwilling to facilitate enforcement of such an award. As a consequence, an arbitration agreement post-dating the dispute is only likely to be an option where both parties have advanced claims against each other and both have concerns about the enforceability of a potential award because the other side’s assets are located outside the jurisdiction, or where the alternative dispute resolution venue (for example, a local court) is unattractive to both disputing parties.

Key takeaway

Parties negotiating a unilateral document should consider carefully whether or not to include an arbitration clause in this contract. While some jurisdictions may recognise arbitration agreements in unilateral documents as enforceable, this does not necessarily mean that a resulting arbitral award will be enforceable in the usual way under the New York Convention. Wherever possible, an arbitration agreement should be concluded between all relevant parties, whether in the guarantee or bond, or in a separate document incorporated by reference.

Careful planning is crucial when it comes to structuring the dispute resolution mechanism in a complex commercial transaction. Dealing with the arbitration agreement at the eleventh hour often means that it is no longer practical to put in place alternative arrangements, such as creating an umbrella arbitration agreement.

Where a guarantor is unwilling to accommodate the non-signatory’s request to adopt one of the practical approaches set out above, parties should carefully consider how significant the enforcement risk is in their particular case and whether it can be mitigated in any other way.

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