Arbitration Clauses in Commercial Contracts: The Small Provision That Can Shape a Major Dispute
Parties often spend months negotiating the commercial terms of a transaction, carefully addressing pricing, timelines, risk allocation and mutual obligations. Yet, when a dispute arises, one of the most important provisions in the entire agreement is often a relatively short clause dealing with dispute resolution.
In recent years, arbitration has become one of the most widely used mechanisms for resolving commercial disputes. Arbitration clauses are now commonly found in investment agreements, M&A transactions, shareholders’ agreements, real estate and construction projects, and other complex commercial arrangements. By incorporating an arbitration clause, parties can shape in advance the manner in which future disputes will be resolved.
What Is an Arbitration Clause?
An arbitration clause is a written agreement under which disputes arising out of, or relating to, a particular contract are submitted to an arbitrator instead of being litigated before the courts.
The clause may be incorporated into the commercial agreement itself or executed as a separate agreement. Once agreed upon, it establishes a dispute resolution mechanism and allows the parties to determine in advance how future disagreements will be addressed.
The primary legal framework governing arbitration proceedings in Israel is the Israeli Arbitration Law, 1968 (“Arbitration Law”).
Why Has Arbitration Become So Popular?
The growing popularity of arbitration is driven by several practical advantages. It often offers a faster process, allows the parties to appoint an arbitrator with relevant industry expertise, provides a greater degree of confidentiality and offers significant procedural flexibility. These advantages explain why arbitration clauses have become an integral part of complex commercial transactions and high-value agreements in recent years.
On the other hand, unlike court proceedings, arbitration generally requires payment of the arbitrator’s fees and, in some cases, additional administrative costs. This is a factor that must be taken into account when selecting the appropriate dispute resolution mechanism.
Additionally, arbitration enables parties to establish review and appeal mechanisms in advance, thereby providing a greater degree of certainty regarding how future disputes will be resolved.
The Independence of the Arbitration Clause
One of the fundamental principles of arbitration law is the doctrine of separability, under which an arbitration clause is treated as an agreement that is independent from the remainder of the contract.
As a result, even where one party argues that the underlying agreement is void, terminated, breached, expired, or otherwise tainted by illegality, such allegations do not necessarily invalidate the arbitration clause itself.
Israeli courts have consistently recognized that an arbitration clause may continue to bind the parties even when the validity of the underlying contract as a whole is disputed. The purpose of this principle is to prevent a party from avoiding arbitration simply by challenging the validity of the agreement.
For example, in Tali – The Society of Film and Television Authors’ Royalties Ltd. v. HOT Telecommunication Systems Ltd. (BSA 19698/08), the court emphasized that allegations concerning the legality of the underlying agreement do not automatically invalidate the arbitration clause.
What Happens If a Lawsuit Is Filed Despite an Arbitration Clause?
Where legal proceedings are initiated despite the existence of an arbitration clause, the defendant may apply for a stay of proceedings and request that the dispute be referred to arbitration.
However, several important conditions apply. The applicant must raise the arbitration objection at the earliest opportunity and demonstrate that it was willing to proceed with arbitration before the claim was filed, and remains willing to do so at the time the application is submitted.
Israeli courts have repeatedly held that delay in invoking the arbitration clause, or active participation in court proceedings over an extended period, may be interpreted as a waiver of the right to arbitrate.
It is also important to note that the appropriate remedy in these cases is a stay of proceedings rather than dismissal of the claim.
The Arbitrator’s Powers During the Proceedings
An arbitrator is vested with broad authority to manage the proceedings, including the power to grant interim relief such as injunctions, mandatory orders, and measures designed to preserve the status quo. These powers are intended to ensure the effectiveness of the arbitration process and to protect the parties’ rights pending the final arbitration award.
Is an Arbitration Award Really Final?
One of the most common questions following the issuance of an arbitration award is whether the award can be challenged.
Under Israeli law, arbitration awards are not automatically subject to appeal. Nevertheless, the Arbitration Law allows parties to establish review mechanisms in advance, provided that they expressly agree to them in the arbitration agreement:
Appeal Before a Second Arbitrator
Section 21A of the Arbitration Law allows parties to agree that an arbitration award may be appealed before a second arbitrator serving as an internal appellate tribunal. Under this mechanism, the original arbitrator must provide a reasoned award, and the appeal is generally decided based on the existing record without rehearing witnesses.
Leave to Appeal Before the Court
Section 29B of the Arbitration Law allows parties to agree in advance that an application for leave to appeal may be brought before the competent court, provided that the arbitrator is required to decide the dispute in accordance with substantive law. Even in such cases, judicial intervention is extremely limited. The court will intervene only in exceptional circumstances where the award contains a fundamental error in the application of the law that results in a miscarriage of justice.
Absence of an Agreed Appeal Mechanism
Where the arbitration agreement does not provide for an explicit appeal mechanism, the arbitration award is final and not subject to appeal. In such circumstances, the only available path to challenge the award is an application to set aside the award, which is strictly limited to the narrow statutory grounds set forth in Section 24 of the Arbitration Law.
Importantly, this is not an appellate review. The court does not examine whether the arbitrator reached the correct factual or legal conclusions, but only whether the award suffers from a fundamental defect that falls under one of the statutory grounds for setting it aside.
Confirmation and Setting Aside of an Arbitration Award
Once an arbitration award has been issued, a party may apply to the court for its confirmation. Upon confirmation, the award obtains the status of a court judgment and may be enforced through Israel’s enforcement and collection system.
Conversely, a party seeking to challenge the award must act within strict statutory deadlines. As a general rule, an application to set aside an arbitration award must be filed within 45 days from the date the award was issued or delivered to the party.
However, where an application to confirm the award has already been filed, the applicable deadline may be shortened to only 15 days from service of the confirmation application, whichever occurs first.
In practice, parties frequently lose the ability to challenge arbitration awards because these deadlines are missed. Accordingly, receipt of an arbitration award or an application to confirm it should prompt an immediate legal assessment of the options available to the party wishing to challenge the award.
Common Pitfalls in Drafting Arbitration Clauses
Many arbitration-related disputes stem not from the arbitration process itself but from poorly drafted arbitration clauses.
Significant attention is often devoted to the commercial terms of the deal, while the dispute resolution provision is copied from previous agreements or left in generic language that is not tailored to the specific transaction.
Common drafting mistakes include failing to establish a clear method for appointing the arbitrator, failing to provide for an appeal mechanism, failing to define the scope of the arbitrator’s authority, and using vague language that does not clearly identify which disputes are subject to arbitration. In many cases, uncertainty regarding the scope of the arbitrator’s jurisdiction leads to preliminary disputes and delays before the substantive issues can even be addressed.
Conclusion
An arbitration clause enables parties to determine in advance who will resolve future disputes, how proceedings will be conducted, and what avenues of review, if any, will be available. For that reason, it should not be viewed as just another standard boilerplate provision. Rather, it is a mechanism with significant implications for the management of future disputes.
Careful and precise drafting at the contract formation stage can reduce procedural disputes, save time and costs, and provide greater certainty if disagreements later arise. In many commercial relationships, it is precisely the relatively short dispute resolution clause that ultimately determines how a future dispute will be resolved.
For further information please contact:
Chen Weinstein, Adv. Aviad bergrin, Adv.
Office: 03-691-6600 Office: 03-691-6600
Email: chen@ekw.co.il E-mail: aviad@ekw.co.il