On 1 December, the Commission on Arbitration and ADR of the International Chamber of Commerce (ICC) issued a report intended to inform users of arbitration of the factors that tribunals consider when allocating costs between parties to arbitration.
A 60-strong Task Force drew on a study of over 300 ICC awards and contributions from eight other institutions (LCIA, PCA, SCC, HKIAC, CIETAC and SIAC). The report summarises some of the trends apparent from those awards, the institutional contributions and the Task Force's experiences under different national legal systems and from arbitration practices across the world. It therefore provides a very useful insight into the approach to costs adopted by many different tribunals in many different contexts.
The report does not endorse a particular approach on the allocation of costs in arbitration. Nor does it seek to provide rigid guidelines for tribunals to follow. However, it re-enforces that tribunals should use the allocation of costs as a case management tool, to ensure parties conduct proceedings in an expeditious and cost-effective manner.
This blog post summarises the key points in the ICC's report and the key conclusions that parties might take into account when engaged in arbitration.
The allocation of costs
The report suggests that the starting point for a tribunal is to identify if the parties have expressly agreed how costs will be allocated between them and to assess whether that agreement is binding (in the UK and Hong Kong, for instance, such an agreement cannot bind the parties unless made after the dispute arises).
In the absence of express agreement, tribunals will look to the rules under which the arbitration is being conducted. Many arbitral rules include a rebuttable presumption that the loser pays the winner's costs (e.g. LCIA, CIETAC, PCA, UNCITRAL and DIS). However, the report concludes that, even where there is no such presumption under the applicable rules (e.g. ICC, HKIAC, SCC and SIAC), a large majority of tribunals adopt the "loser pays" approach as a starting point.
However, determining the relative success and failure of each party in complex arbitrations may not be straightforward. In such cases, tribunals may start from the "loser pays" principle, but apply it in different ways. The report comments that "the general approach is to assess the degree and scope of success and, where relevant, the timing of that success".
A less frequently used, but alternative starting point for tribunals in determining cost allocation is to follow the "American Rule". This reflects the approach traditionally applied in the jurisdictions of the United States, whereby the starting point is for each party to bear its own costs. However, even tribunals following this approach to the allocation of parties' legal costs may then still decide to allocate the arbitration costs between the parties (i.e. the arbitrators' fees and administrative fees). According to the report, a review of 221 ICC awards from 2012 revealed that arbitration costs represent on average 17% of the parties' total costs.
Conduct of the parties
Consistent with the increasing emphasis placed on procedural efficiency and effective case-management in the most recent institutional rules, the report found that "the parties' procedural behaviour was systematically taken into account by a majority of tribunals". Dealing with the position of tribunals acting under the 2012 ICC rules, the report states that "the 'costs follow the event' rule is considered less as a starting point and more as one of the principal factors to be considered when allocating costs, along with the parties' conduct that occasioned the arbitration and whether the parties conducted the arbitration in an expeditious and cost-effective manner." This confirms that a party's conduct might, in certain circumstances, cause a tribunal to depart from the commonly-used "loser pays" principle.
Reasonableness of costs
Irrespective of the starting point, most of the awards studied in preparation of the report illustrate that tribunals will assess the reasonableness of the costs claimed (which is consistent with Article 37(1) of the 2012 rules, which empowers the tribunal to award "reasonable legal and other costs incurred by the parties for the arbitration"). The factors taken into account in determining reasonableness vary from one tribunal to the next, as there is no accepted definition of "reasonable costs". However, in the awards studied for the report, tribunals considered: (i) the ratio between the overall costs claimed and the value of the substantive claim (this can include a review of the rates applied, the legal team resourcing, disparity between parties' costs); and (ii) whether the work performed was reasonable and proportionate (considering the complexity of the matter, how accurately the parties depicted their claims, any vexatious claims or counterclaims, any unnecessary delay, unnecessary reliance of witness and expert evidence, approaches to procedural issues).
Unsuccessful settlement negotiations
The report reveals that tribunals have accepted that unsuccessful settlement negotiations are part of a party's preparation of the arbitration and that the associated costs are therefore, in principle, recoverable.
The report also highlights that tribunals may take into account any settlement offers that the parties have made during the proceedings when reaching a decision on costs (much like the Part 36 procedure under English civil procedure rules). Of course, such offers should not be brought to the tribunal's attention before final determination on the merits: one potential solution to this problem highlighted in the report is for any such offer to be communicated to the ICC Secretariat on the basis that it will be forwarded to the tribunal only once it has reached its decision on the merits.
Third party funding, success fees and uplifts
The report highlights some of the issues commonly discussed in relation to third party funding and concludes that the general rationale for allocating costs to a successful party is that it should be no worse off as a result of vindicating its rights. The tribunal therefore needs to determine whether the party in question actually incurred the costs it is seeking to recover. However, the report observes that only a few of the awards reviewed had considered success fees.
The report confirms that there is generally no obligation in arbitration for a party to reveal its third party funding arrangement. However, the report also suggests that tribunals might consider ordering disclosure of "such financial information as is necessary to ensure that the process remains effective and fair for both parties", if third party funding arrangements might impact upon a non-funded party's ability to recover its costs.
In-house legal costs and management time
The report comments upon the allocation of "internal legal, management and other costs". Even though most arbitral rules are silent on the recovery of such costs, the report concludes that tribunals have discretion to award such costs. This occurred in some of the awards considered, where the tribunal found the costs were "necessary, did not unreasonably overlap with outside counsel fees, were substantiated in sufficient detail…and were reasonable in amount".
Although the report is not intended to provide guidelines or an endorsement by the ICC of any particular approach to cost allocation, it reveals certain trends and provides a rare insight into factors tribunals have considered relevant.
The report gives particular focus to the use of cost allocation as a mechanism through which tribunals can "assist in creating fair, well-managed proceedings matching users' expectations". This is consistent with the changes in the 2012 ICC rules and, in particular under Article 37(5), where a tribunal is required to consider whether party has "conducted the arbitration in an expeditious and cost-effective manner". As mentioned above, the parties' conduct might cause tribunals to depart from the commonly-used principle that "loser pays the winners costs".
It is unwise to be too prescriptive about what steps parties should take regarding the allocation of costs in any given arbitration. The reality is that best practice might vary from one case to the next. However, the report provides supporting examples that might impact on the way parties manage and record their costs during the proceedings.
First, where the parties have reached a clear (and binding) agreement on the allocation of costs, tribunals will generally enforce that agreement. If it was not possible (either commercially or legally) to include this in the arbitration agreement, the parties might consider if it is possible and appropriate to agree the allocation of costs once the dispute has arisen. Alternatively, the parties and the tribunal might try to agree at an early state what principles the tribunal will consider when making its decision on costs. This might also help to flush out relevant information about third party funding and/or the need for a non-funded party to apply for security for costs.
Second, each party needs to substantiate its costs incurred throughout the proceedings and accurately record any factors that might impact upon the tribunal's decision (e.g. conduct of the other side and any resulting impact on costs). The report also confirms that parties might gain from maintaining accurate and comprehensive records of internal time and costs spent directly as a result of the arbitration (both legal and management), to support a claim for these costs.
Finally, the report acknowledges tribunals' ability to take into account offers to settle (and the parties' general conduct in relation to settlement) when it comes to costs. While this approach is familiar in England, the report illustrates that such "without prejudice save as to costs" offers can also be an effective tool in arbitration.
For further information, please contact Chris Parker, Partner, Charlie Morgan, Associate or your usual Herbert Smith Freehills contact.