Cost Allocation Rules in Arbitration: A Solution to Frivolous Claims?
Arbitration is preferred over litigation for many of its perks however, the cost of the arbitration proceeding is often cited as a drawback. There was a time when International arbitration was considered cost and time effective. However, in recent years it has been argued that international arbitration has become more complex and expensive. Although international disputes can be expensive regardless of the dispute resolution method chosen by the parties, arbitration can prove to be more expensive than litigation, especially in complex and time taking disputes. The comparatively higher cost of arbitration, as opposed to litigation, tends to be a rational quid pro quo in jurisdictions afflicted by frivolous litigation that frustrates the reasonable expectations of commercial parties. When faced with the potential cost of the arbitration, a litigant who is a party to an arbitration arrangement is less likely to pursue a frivolous or unfounded claim. In this regard, cost allocation in an arbitration proceeding becomes very important. Three rules are followed around the world for cost allocation: ‘loser pays’, also known as the ‘English rule’; ‘pay your own way’, also known as the ‘American rule’; and ‘pro rata’ approach. In this article, the main focus would not be how the tribunal may decide what may constitute a frivolous claim but rather the merits and demerits of all three rules, and which of these would be more suitable to control frivolous claims.
Cost Allocation Rules: International Arbitration
The cost allocation in International commercial arbitration has a topic of concern for parties, scholars as well as the practitioners. Broadly, the cost associated with arbitration proceeding is of two categories: ‘arbitration costs’ also known as procedural costs and the ‘parties' costs. Where in, the arbitration cost may cover: arbitrators fee [As well as Value-Added Tax (VAT) applicable on their fee], travel and accommodation charges of arbitrators, the registration fees and administrative costs of the arbitral institution (if applicable), the fees and expenses of tribunal-appointed experts, and booking of the hearing room, etc. The latter category “parties’ cost” may include the fees and expenses of legal representation, the expenses related to witnesses, and the costs covering the time spent by a party’s in-house resources, etc. 
Cost allocation rules are the starting points for the determination of cost in the arbitration proceeding. These rules act as a tool, using which litigants create or alter incentives, including deterring claimants from bringing claims without legal merit and abuse of process claims. Parties do not often provide concrete guidance for arbitration costs in their agreement,  and then it is upon the tribunal to decide on a case to case basis as to how the cost should be allocated among the parties.
There is no uniform approach in the international arbitration arena for allocation of cost and it has broadly been flexible. This is the reason that the discretion of arbitral tribunals is remarkably divergent in this field. The most commonly used approaches by the practitioners are: ‘loser pays’; ‘pay your own way’; and ‘pro rata’ approach.
The Losing Party pays it all
English rule, also known as Loser Pays or Costs Follow the Event, follows an outcome-based approach. As per this approach, the winning party gets indemnified by the losing party for the entire legal cost incurred. Many institutional rules include the provision specifying this approach as a rebuttable presumption (e.g. LCIA, CIETAC, PCA, UNCITRAL and DIS). It has also been noted that even when there is no such provision in the applicable rules, the majority of tribunal adopts losers pays approach, at least as a starting point. According to a survey, this is the most dominant approach in most common law as well as some civil law countries.
This approach has been supported by many countries for various policy-based reasons, including-
to punish the losing party;
to indemnify the winning party;
Most importantly, discouraging the frivolous and bad faith claims.
Indian law commission in its 276th report, while suggesting cost follows the event approach for domestic arbitration also reasoned it as an “efficient deterrence against frivolous conduct and furthers compliance with contractual obligations.” Losers pay is said to be traditionally punitive in nature. Many scholars have tried to justify its modern application by arguing that an innocent party should not suffer the expense of a claim deemed not to be found in law and justice.
The usage of this rule is so prevalent that some of the practitioners go so far as to say that they may be considered a “general Principle of International Law”. The approach has both advantages and disadvantages. As noted by researchers, the approach essentially barred claims with little legal merit, and its default application may even hinder the development of the law. Further, it is difficult to determine the actual winner in arbitration proceedings. This brings us to, the second most dominant approach in international arbitration, i.e., Pro-rata.
Pro-rata, also known as Apportionment of Costs or Proportional Allocation, is also an out-come based approach. This unlike losers pay is dependent on the conduct of the parties during the proceeding, the degree of their legal merits, and their success in the dispute. An example of this approach can be given by an ICC case no. 11869. In this case, the winning party won the majority of the claimed amount and hence the losing party was asked to pay 85% of the procedural cost as well as 85% of the Legal cost of the winning party. Another example of this approach can be the ICC case no. 14020, here both the parties succeeded in part and failed in part. Hence, both the parties were asked to pay their own legal cost and the procedural cost was equally divided.
In theory, this approach may seem easy. However, it has been noted that the monetary outcome does not reflect the actual balance of success of the parties. Moreover, determining parties’ success and conduct during the proceeding can be a difficult and complex task. The approach has also been criticized for failing the fairness test as the parties may claim unreasonable legal costs with significant discrepancy.  Further, most parties prefer to know an estimation of the cost before starting arbitration proceedings. As observed by Michael O’Reilly “[t]he topic of costs is hardly glamorous […]. Although it is the last thing to be dealt with in any arbitration, it is usually the first thing on the client's mind.” The proportional approach may fail to provide clients with certainty.
Pay your own way out
Pay your own way out, also known as the American rule, is the least used rule and is independent of the outcome. This rule requires each party to pay its own expenses. In comparison to its counterpart English rule, under American rule, a party will only bring a claim if and only if “the expected award amount would be at least as large as his legal costs”. As per this rule, the procedural costs are shared equally and the parties’ bear their legal costs unless agreed otherwise.
The roots of this approach can be seen in English common law however, it has been maintained in the American legal system. The American legal system defends this approach by following reasons:-
The outcome of any proceeding is often uncertain and each party would try its best to defend their claim, hence punishing the losing party for defending its claim would be unfair.
This may lead to discouraging the poor from instituting actions to bring/defend its claim.
Shifting of costs would most likely increase “the time, expense and difficulties of proof” in any given case and “would pose substantial burdens for the administration of justice”.
Another argument raised in favour of this approach, in arbitration, is that “both the parties agreed by contract to create a special forum which is privately financed, hence they should in fairness pay in equal measure the costs of setting in motion and operating such a consensual regime.” Moreover, this approach is said to encourage promising claims and lower the barrier to opting for arbitration. However, this method may prove to be unfair in the cases of frivolous claim where the innocent party has been dragged to a dispute.
Cost in arbitration matters. As the cost continues to rise in international commercial arbitration, concerns regarding costs rise along. The parties coming to arbitrate want to know how much the dispute resolution process will take. Although most of the countries apply English rule, the allocation of costs in international commercial arbitration is an area where the approaches, opinions, and principles are somewhat diametrically positioned. On one hand, the outcome-based approach may prove helpful to deter bad faith claim, it has often been criticized for being unpredictable, as there is no consensus on the factors which will be taken into account eventually. There is a need to harmonize the rules for cost allocation and make certain systemic changes to promote consistency and certainty in the application and interpretation of the legal rules.
While in most of the countries English rule is followed, i.e., losing party has to bear all the expenses of the arbitration as well as parties’ legal cost, it should be noted that there is no consensus on what cost may be awarded to the prevailing party and how that should be apportioned. While many rules specify that the arbitration tribunal is found to decide the allocation of cost, they do not specify any rule for the same. Some certainty with respect to rules might aid in deterring frivolous and bad faith claims. If the parties and their counsels coming to arbitration have a general idea of the cost, it might discourage them from bringing claims with little or no legal merit. The same was also noted in the Indian Law Commission report.
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