How Does Arbitration Work? An introduction for the Layperson

A Story Instead of an Introduction

Harry was a skilled baker, renowned for the fresh, high-quality, and flavorful éclairs he proudly offered. One day, a customer, Hermione, decided to purchase a kilo of his éclairs. Before making the purchase, Hermione asked Harry multiple times if the éclairs were truly delicious. With unwavering confidence, Harry assured her of their freshness and quality, promising that he would refund her money if any of the éclairs turned out to be stale. He even added that she was welcome to bring anyone she wished to judge their taste and quality.

However, as misfortune would have it, the cream inside the éclairs was spoiled. Hermione was outraged. Without delay, she returned to Harry's bakery, demanding a refund. But Harry, wearing a sly expression, dismissed her complaint. "When you bought them, they looked perfectly fine on the outside," he said, shrugging. "How could I have possibly known what was inside?"

Despite his earlier assurances, Harry refused to acknowledge the poor quality of the éclairs, denying Hermione any refund. Frustrated and disappointed, Hermione stood at the counter, realizing that the baker’s promise had been nothing more than empty words.

As the argument between Harry and Hermione escalated, Tom, a mutual friend of both, happened to be present. Hoping to resolve the matter fairly, Hermione suggested that they let Tom decide. Harry readily agreed. Both parties made it clear that they would accept Tom's decision as final and binding.

However, Tom glanced at his watch and said, "I'm in a bit of a hurry right now. I'll hear both sides and settle the dispute tomorrow." He then added with a grin, "But for my efforts, you two owe me a cup of coffee." Harry and Hermione exchanged looks and agreed, replying in unison, "Yes." They also decided to split the coffee bill equally, sealing the terms of their agreement with a nod.

Now consider that the dispute is over the supply of high-quality iron for use in construction projects, not éclairs. Unlike the original agreement between Harry and Hermione, this one is between a construction company and an iron factory. In order to resolve the dispute, both parties agree to appoint an expert in construction to replace Tom as arbitrator. As stated in their agreement, the arbitrator's decision will be final and binding.

I. Arbitration & Alternative Dispute Resolution

Arbitration is one form of alternative dispute resolution ("ADR"), alongside other methods such as conciliation, mediation, negotiation and various combinations of these. These approaches provide alternatives to the traditional method of dispute resolution - litigation. The primary objective of ADR methods is to resolve disputes in an efficient and cost-effective manner. Among them, arbitration stands out because of its binding nature, which makes it more enforceable than other methods. As a result, arbitration has become the preferred mechanism for resolving both domestic and international commercial disputes. In commercial disputes where parties wish to avoid unnecessary financial loss and delay - unless they are pursuing a self-defeating course arbitration offers a practical solution that minimises both time and cost.

Also, arbitration can be seen as a specialised form of court administered by an expert judge. In many business agreements, despite efforts to prevent disagreements, disputes may arise over certain issues. In such situations, it is often preferable to resolve the conflict through arbitration rather than escalate it to litigation. Globally, arbitration has become a widely favoured method of resolving commercial disputes, involving one or more arbitrators chosen by mutual agreement of the parties. A key advantage of arbitration over traditional litigation is the ability to appoint subject matter experts as arbitrators. This specialised knowledge ensures a faster resolution, as decisions are made by professionals with in-depth knowledge of the relevant field.

A. Arbitration Agreement/Clause 

At the heart of the arbitration process is an arbitration agreement, which forms the basis for private dispute resolution outside the traditional court system. It is a legally binding contract by which the parties agree to submit their disputes to arbitration, either in advance (through a clause in the main contract) or after a dispute has arisen (through a separate agreement). With the increasing complexity of international and domestic commercial transactions, arbitration agreements have become indispensable tools for managing risk and ensuring efficient dispute resolution. 

By allowing the parties to choose arbitration as an alternative to litigation, an arbitration agreement reflects the principle of party autonomy. It serves two main purposes: 

• Exclusion of jurisdiction: It waives the parties' right to seek resolution of disputes covered by the agreement in national courts. 

• Binding commitment: It obliges both parties to abide by the arbitrator's final decision, which has the same legal force and enforceability as a court judgment. 

Arbitration agreements are either incorporated into the main contract as arbitration clauses or agreed separately after a dispute arises. In either form, the agreement defines the scope of the arbitration, including the type of disputes covered, the rules to be applied, the seat of the arbitration and the mechanism for appointing arbitrators. 

The arbitration agreement must clearly reflect the parties' intention to resolve the dispute by arbitration. Only disputes that are considered "arbitrable" under the applicable laws may be submitted to arbitration, but certain matters, such as criminal cases or family law disputes, are outside the scope of arbitration. In addition, the agreement should clearly define the types of disputes it covers. A well-drafted arbitration clause minimises ambiguity and ensures that issues relating to the performance, breach or interpretation of the contract are properly covered. In addition, arbitration agreements often specify procedural rules - such as those of the Istanbul Arbitration Centre (ISTAC) or UNCITRAL - and the seat of the arbitration, which ultimately determines the procedural law governing the arbitration. 

For instance, parties wishing to refer to arbitration under the Istanbul Arbitration Centre Arbitration Rules, may adopt the following model arbitration clause by making the necessary modifications according to their particular circumstances, and use this as an arbitration agreement: 

"Any disputes arising out of, or in connection with the present contract shall be finally settled through arbitration under the Istanbul Arbitration Centre Arbitration Rules." 

The following provisions may be added to the model arbitration clause: 

• "The Emergency Arbitrator Rules shall not apply. 

• The place of the arbitration shall be (City/Country). 

• The language of the arbitration shall be (…). 

• The number of the arbitrators shall be (…). 

• The law applicable to the merits of the dispute shall be (…).

United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards ("New York Convention") plays a pivotal role in ensuring that arbitration agreements and awards are enforceable across borders. Most countries, including major commercial hubs, are signatories to the Convention, which requires courts to respect and enforce arbitration agreements unless there are grounds for invalidity, such as incapacity or lack of arbitrability.

B. Arbitrator(s) 

Disputes are referred to an arbitral tribunal, which may consist of a sole arbitrator or a panel of arbitrators. In the past, arbitral tribunals could include two arbitrators, but this often led to significant difficulties in reaching a consensus. As a result, it has become a legal requirement to have an odd number of arbitrators. Typically, high-stakes disputes involve three arbitrators, while less complex matters are usually decided by a sole arbitrator. The sole arbitrator is appointed by mutual agreement of the parties. In cases with three arbitrators, each party usually appoints one arbitrator and the third is chosen by the two appointed arbitrators. 

Regardless of the method of appointment, certain essential qualities define an ideal arbitrator. However, it is often difficult to find an individual who embodies all of these qualities. The most important quality is impartiality coupled with impeccable integrity. Large corporations, with their considerable resources and influence, may seek to influence the arbitrator's decision. It is therefore imperative that the arbitrator remains steadfast under such pressure. In addition, factors such as language skills, legal expertise, relationship with the parties, availability and relevant experience play an important role in the appointment of an arbitrator.

C. Award

The decision made by the arbirator(s) is known as an award, which is final and binding on both parties. However, there are certain grounds on which an arbitration award may be subject to challenge in a court of law.

II. Notes For Laypersons 

Is arbitration a good method of dispute resolution? Companies or entrepreneurs should understand that it is not mandatory to choose arbitration as a dispute resolution mechanism. However, it should be noted that arbitration has more advantages than local courts in terms of speed, cost and confidentiality. 

Appointment of an arbitrator: This is a million-dollar point. The arbitrator is the linchpin of the arbitration. Everything depends on them. It is therefore very important to appoint the right person as an arbitrator. Anyone can be appointed as an arbitrator. There are no statutory qualifications. However, it is desirable for the arbitrator to be an expert in the field and to have some understanding of legal issues. It is therefore advisable to choose an arbitrator who understands the substance of your case and will make a decision on the same basis. 

Applicable law: This is a point that needs to be answered in international contracts. First of all, two laws have to be agreed. One is contract law, the other is arbitration law. In most cases these two should be the same. For example, in the story above, let's say Harry and Hermione are from two different countries (A and B respectively). Should Harry's or Hermione's law be contract law and/or arbitration law? There is no formula for deciding. Harry may feel uncomfortable in B and Hermione may feel uncomfortable in A. In such a case, they may even make a decision in another country.

Oğuzhan Karlı, LLB.