The virtues of arbitration as a method of resolving commercial disputes are well-known. The primary benefits of arbitration over the conventional court system are the reduction in costs and delays. However, during a recent conversation with a senior corporate counsel, I was given to understand one drawback in using arbitration as a method of resolving disputes in corporate law. And, that is its inability to develop the body of corporate jurisprudence through judge-made law and interpretation. Given that one of the key features of arbitration is the confidentiality of proceedings, the arbitral awards and the reasoning of arbitrators neither operate as precedents (even if they are not binding in subsequent cases on the lines of stare decisis) nor are they even available for consideration subsequently by courts or other arbitrators.
An apt example of this limitation is the arbitral award in the Sterlite-Balco case, which was on a vexed issue of law concerning restrictions on transfer of shares. Although there has been some amount of debate on that arbitration due to its high-profile nature, much of it is based on secondary sources with no public access available to the terms of the award and its reasoning. For instance, one question that remains unanswered is why the arbitrators disregarded restrictions on transfer of shares in contractual arrangements despite a clear ruling to the contrary by a division bench of the Bombay High Court in the Messer Holdings case. For these reasons, the corporate counsel I spoke with suggested an interesting via media, which is to develop a system whereby the principles of law developed in arbitral awards are documented on a no-names basis without reference to specific cases or their facts. That would at least preserve the reasoning for subsequent consideration, reliance and use.
While these issues require some thought, two separate episodes occurring in the US have raised further questions about the use of arbitration in corporate disputes. First, the Delaware legislature has adopted a provision in its corporate law that permits resolution of corporate disputes through a confidential arbitration process. This has attracted a lot of attention because the arbitrators would effectively be judges of the court that adjudicates corporate disputes. As the Race to the Bottom blog notes:
What made the provision unique was the identity of the arbitrator. The provision provided that the Court of Chancery had “the power to arbitrate business disputes when the parties request a member of the Court of Chancery, or such other person as may be authorized under rules of the Court, to arbitrate a dispute.” 10 Del. C. § 349. In effect, therefore, parties would get the benefit of one of the Chancellors/Vice Chancellors at the Delaware Chancery Court (or one of the court masters).
It further notes that a constitutional challenge has been mounted to that provision on the ground that it restricts access to free trial.
Second, in its IPO offering document, Carlyle recently inserted an arbitration provision to resolve shareholder claims that effectively barred securities class action litigation. The Deal Professor studies its impact:
The thing that pushes Carlyle’s corporate governance structure over the edge is the arbitration requirements. Carlyle is requiring that public shareholders arbitrate all claims against the company. The arbitration must be confidential, meaning no one would ever even know about it unless it was required to be disclosed by another law. Class-action lawsuits are specifically barred.
The effect of these three provisions is to essentially eliminate any ability of shareholders to sue the board for even the most egregious acts. This includes federal securities law claims as well as any state law claims, though to be honest any grounds for state law claims have largely been eliminated anyway. The costs to most shareholders of bringing this type of litigation are prohibitive unless a class action is available.
However, due to stiff resistance from the Securities and Exchange Commission (SEC), Carlyle was forced to drop the arbitration clause in its offering document. While this seems entirely reasonable, some commentators (here and here) believe that the clause should have been retained since investors have the final choice in whether to invest in the stock or not, and whether to discount its value due to the presence of limitations on class action remedies.
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