“Investment arbitration” is a hot topic not only but also because the Europeans refuse to accept the respective dispute resolution mechanism in the TTIP-discussions with the United States of America. In this context, arbitration is a means to protect a past investment against undue influence exercised by the host state. However, a slight change of the term “Investment Arbitration” into “Investment: Arbitration!” gives rise to a different discussion. The term then indicates that an arbitration proceeding is always an investment in and by itself. Parties invest in the resolution of a dispute. That aspect is frequently overlooked or deliberately ignored. To put it bluntly: Parties all over the world complain that arbitrations have become too costly and the trigger word “costs” already indicates the negative, if not hostile attitude the parties take vis-à-vis arbitration proceedings. Arbitrations are perceived as a necessary evil that, if not completely avoidable, should be terminated at the lowest costs possible. “Costs, costs, costs” – nothing else seems to be more important. What people ignore is that an arbitration proceeding is an investment often promising an extremely high return on investments, “ROI” in managers’ lingo.
What is meant by “Investment: Arbitration!” promising a high ROI is best illustrated by an example:
Alpha is a construction company. In a large project, Alpha acts as general contractor for the owner Beta. Alpha may now have a EUR 10 million claim against Beta for having performed out of scope works and for damages resulting from various disruptive events. Settlement negotiations between Alpha and Beta have failed. The only way Alpha can get a hold of the additional EUR 10 million is to initiate arbitration proceedings. Let us assume that those arbitration proceedings will cost Alpha EUR 1 million for arbitrators’ fees and, especially, for counsel representation. If the Alpha succeeds in the arbitration, Alpha will get EUR 10 million for an initial investment of EUR 1 million, that is an ROI or profit margin of 900 %! This calculation even ignores Alpha’s cost reimbursement claim against Beta. Can there be a wiser investment? The counter-argument probably is that the ROI is not sure, since the arbitration can also be lost. That is true, but that is also true for almost every investment made in the business world. Let us assume that Alpha’s initial chances to succeed are only 30 %, would it still be a wise investment to pursue the arbitration? Of course it would, as simple math will demonstrate: A prospective outcome of EUR 10 million pursued with a chance of 30 % has an actual value of EUR 3 million (EUR 10 million × 30 %). And since this actual value of EUR 3 million is still three times higher than the required investment in the arbitration it is a no-brainer that the investment must be made.
Tackling this investment issue from a different angle: Let us assume that Alpha’s operating profit margin in its key business area, namely construction, is 5 %. Accordingly, Alpha needs a EUR 200 million project to generate a profit of EUR 10 million. Now, the outcome of an arbitration is always pure profit (not only turnover!), since either Alpha gets an additional EUR 10 million (= profit!) or Beta must not pay an additional EUR 10 million (= avoiding a loss directly reducing the profit). In both projects, the construction project or in the arbitration project, Alpha can make an ultimate profit of EUR 10 million. For pursing that chance for a profit, Alpha must invest EUR 190 million in the construction project but only EUR 1 million in the arbitration! So what is the wiser investment decision? The answer is clear but rarely reflected in the investment decision actually taken: You bet, that Alpha will, in the construction project, make initial investments of millions, setting up a complete project structure with project directors, office space and employees. And in the arbitration? In all likelihood, Alpha’s entire project structure consists of one poor, already overworked in house – counsel, who can devote only part of his time to the arbitration and whose primary instruction often is “Keep costs down and within budget!”. With such a set-up, the investment perspective is completely lost.
Why is this observation so deplorable? Parties immediately switch into a cost-saving mood when they hear the word “arbitration”. In order to save costs, no project structure is established. In order to save costs, parties tend to pursue a “wait and see” approach. Parties do not invest in an initial comprehensive fact-finding or in gaining solid evidence by instructing outside experts. All too often this cost-saving approach is continued when selecting external advisors (law firms, experts etc.), looking for the cheapest hourly rates, as if buying advice in an international arbitration is a commodity such as buying paper.
What is the foreseeable result of this single-focused, cost-saving approach? Again, compare it with the construction industry: If a company strives to save costs in the beginning, relying on poor planning and project management, buying the cheapest materials available on the market, the project itself will suffer and with the project the company’s profit margin. A small project delay or quality problem can then evaporate the entire ROI so carefully planned. The investment has failed. The very same can happen in an arbitration if the investment made is inadequate to stakes in dispute. In the world of construction projects and in the world of international arbitration it happens rarely that some benevolent elfs save a mismanaged and underfinanced project.
Has the reader spotted some angriness in the above lines? Rightly so! Isn’t this article overly argumentative, even a kind of Philippic against the cost-saving focus many companies pursue with some good reason? Maybe. And isn’t it true that these lines have been written by somewhat biased persons who, being part of the arbitration industry themselves, have an egoistic interest in higher investments? Sure and accepted! But all that doesn’t change the gist of this article: When parties are involved in an arbitration they have to make an investment. Parties should not take the decision what to invest in the arbitration proceedings solely based on costs, but they must also consider the expected return of investment and the chances to increase the likelihood of success, i.e. actually realizing this ROI. Accordingly, the predominant cost-focus should be replaced by an investment focus. It is wise to concentrate on “Investment: Arbitration!”.
