Lesson 6 – Decentralized Arbitration Enforcement Framework

One important question has to be answered: what if a dispute arises? After all, a Decentralized Law only has value if it can be enforced.

Suing a contracting party in a traditional court system can be problematic; it is often a lengthy process and language, lack of knowledge or neutrality may be an issue. What’s worse is that a ruling in one country is often not directly enforceable in another due to differences in legal systems.¹⁾Yuliya Zeynalov, “The Law on Recognition and Enforcement of Foreign Judgments: Is It Broken and How Do We Fix It?,” (Berkeley Journal of International Law, Volume 31, Issue 1, 2013), accessed April 6, 2018, https://scholarship.law.berkeley.edu/cgi/viewcontent.cgi?article=1435&context=bjil, page 152.
“this study concludes that the absence of an international enforceability regime for foreign judgments leaves a void in the realm of private International Law that sits in stark contrast to the well-established mechanism for enforcing foreign arbitral awards.” The concept of international arbitration was thus developed to tackle this issue.

Arbitration is a private court system for resolving disputes. It has the following characteristics: ²⁾Margaret J. Moses, “The Principles and Practice of International Commercial Arbitration,” 3rd Edition, (Cambridge University Press, London, 2017): Combination of characteristics selected from Chapter 1

• Parties who arbitrate have decided to resolve their disputes outside any judicial system.
• In most instances, arbitration delivers a final and binding decision, producing an award that is enforceable in a national court.
• The decision makers, usually one or three, are generally chosen by the parties.
• The parties are free to choose the governing laws as well as the seat and rules of arbitration.
• Parties can choose the place of arbitration and the language of arbitration.
• The power of the arbitrators to decide on a case depends on the explicit consent of the parties.
• Neutrality of the forum (staying out of other people’s courts).
• The possibility to keeping proceedings and the resulting award confidential.
• The use of arbitrators with knowledge on the subject matter as compared to local judges.
• Less discovery, as compared to full scale litigation.
• The lack of opportunity for multiple appeals. Achieving a result in a short period of time.

The Arbitration Agreement

An arbitration agreement creates a unique body of private law. Those involved consent to be subjected to this body of law by signing the agreement. The result is that arbitration courts can only rule on matters agreed upon in the contract. It is therefore recommended that arbitration agreements are written as broadly as possible. This way, they cover both disputes arising out of the contract’s text, but also those based on tortuous acts or unfair business practices.³⁾Margaret J. Moses (2017): Chapter 2, B, 2, A

It is thanks to the New York Convention (1958) that arbitration awards are enforceable in almost any country in the world. During the convention, it was agreed that arbitration cases decided in the correct form in one of the contracting States are directly enforceable in other States without the need for a local court case.⁴⁾“Convention on the Recognition and Enforcement of Foreign Arbitral Awards,” United Nations, (New York, 1958), accessed April 6, 2018, https://treaties.un.org/doc/Treaties/1959/06/19590607%2009-35%20PM/Ch_XXII_01p.pdf At present, 161 countries are part of the New York Convention.⁵⁾ “Contracting States – List of Contracting States,” New York Arbitration Convention, accessed on December 16, 2019, http://www.newyorkconvention.org/list+of+contracting+states

Within the framework of international arbitration, contracting parties are completely free to create their own private systems of law. A contract signed within the correct framework―or a Consensus Jurisdiction―enjoys the full protection of the legal system almost anywhere in the world!

The Legal Framework for International Arbitration

In lesson 4 we learned what a legal framework is. Let’s look look at the framework for international arbitration. This model comes from the book on International Arbitration by Margaret J. Moses (2017), who describes it as an “inverted pyramid” where higher laws govern underlying laws: ⁶⁾Margaret J. Moses (2017): Chapter 1.E, The Regulatory Framework

Governing Laws

What makes international arbitration interesting is that it provides the contracting parties the freedom to choose governing laws. This is usually a national law, such as English law. An obvious reason for this is that it is written in English. In addition, it has been used in international business for centuries. Moreover, it is transparent, predictable and flexible as it offers complete freedom of contract.⁷⁾“England and Wales: The jurisdiction of choice,” The Law Society of England and Wales, accessed April 10, http://www.eversheds-sutherland.com/documents/LawSocietyEnglandAndWalesJurisdictionOfChoice.pdf

However, there are also examples of “bottom up” laws that have been created by private parties, and not by governments. One example is Lex Mercatoria, mentioned in the lesson about private law.

The Seat of Arbitration

The New York Convention requires contracting States to recognize and enforce arbitration awards made in other contracting States. This again refers to a physical location. For this to work, a “Seat of Arbitration” is required in one of the participating States. This goes against the concept of decentralization. But this issue is not new.

Online Arbitration already exist. An example is the service offered by the Hong Kong International Arbitration Centre, which offers a completely online arbitration procedure.⁸⁾Margaret J. Moses (2017): Chapter B3B, Online Arbitrations Hong Kong becomes the seat of such arbitration and a ruling therefore becomes enforceable due to the New York Convention.

Delocalization versus Decentralization

Moreover, the concept of decentralized arbitration itself is not entirely new. In the 1980’s, passionate arguments were made for the “delocalization” of arbitration. Delocalization is also referred to as “Stateless,” “floating” or “a-national” arbitration. It is based on a theory that local laws should not influence an International Arbitration.⁹⁾Margaret J. Moses (2017): Chapter 4B, Delocalization V. Territoriality

Providing valuable insight, Moses (2017) gives an important example of the result:

“One response to the delocalization movement was a law passed in Belgium in 1985. It provided that parties to an arbitration in Belgium who were not Belgian citizens and did not have a business located in Belgium would not be permitted to apply to a Belgian court to set aside an arbitral award. There would thus be no judicial review of the award in Belgium. It was believed at the time this would increase the number of arbitrations in Belgium. In fact, however, the law had the opposite effect. Businesses were not drawn to a system with no possible court review. It appeared instead that businesses were avoiding it as a place of arbitration.” ¹⁰⁾Margaret J. Moses (2017): Chapter 4B, 2, Arguments Opposing Delocalization

It appears that for those involved in international business, an arbitration case with reduced oversight is considered less attractive. Two other studies had similar observations of arbitration in general. Eisenberg and Miller (2006) observed that from a sample of contracts filed by multinationals, only 20% contained arbitration clauses compared to 10% of domestic contracts.¹¹⁾Theodore Eisenberg and Geoffrey P. Miller, “The Flight from Arbitration: An Empirical Study of Ex Ante Arbitration Clauses in Publicly-Held Companies’ Contracts,” (New York University Law and Economics Working Papers, New York, 2006). Paper 70. http://lsr.nellco.org/nyu_lewp/70 [link no longer works], page 2 And Ya-Wei Li (2006) concluded that only 15% of the international contracts studied opted for arbitration as a means of dispute resolution (of a small sample however).¹²⁾Ya-Wei Li, “Dispute Resolution Clauses in International Contracts: An Empirical Study,”  (Cornell International Law Journal: Vol. 39: Iss. 3, Article 15, 2006) Accessed April 7, 2018, http://scholarship.law.cornell.edu/cilj/vol39/iss3/15, page 799

This would indicate that the traditional court system is still very popular amongst those active in multinational operations. Apparently, when money is on the line, contracting parties opt for the (perceived) security that the State’s justice systems provide.

While international arbitration has not removed the demand for traditional court systems, we can conclude that international arbitration is a working system currently being used in real contracts. It can therefore be used as the enforcement framework for Decentralized Law.

Projects Targeting Decentralized Arbitration

There are a number of active projects in the Crypto-Space regarding arbitration. For this study,¹³⁾Study was done in 2018, some of these projects have evolved and their current documentation no longer reflects the original project the whitepapers of Aragon, Bitnation Pangea, Kleros and Jincor alongside the proposal of DAMN¹⁴⁾Pamela Morgan, Andreas M. Antonopoulos, “Decentralized Arbitration and Mediation Network (DAMN),” Third Key Solutions, LLC, accessed April 11, https://github.com/thirdkey-solutions/damn/blob/master/proposal.asciidoc were analyzed.

Something in common to all of these projects is the lack of reference to seats of arbitration or legal frameworks. In fact, Bitnation Pangea is the only project that mentions a legal framework and the development of law, but not in the context of enforcement in the real world. DAMN is the only project that intended to research the possibility match the decentralized world with the legal world, but the project went nowhere.

Ideas on Enforcement of Rulings

There are a two recurring ideas on how decentralized rulings should be enforced: by reputation or by Smart Contract.

We saw in the analysis of International Law that a system based on reputation and consensus could work. But who says that individuals online care as much about their reputation on a specific network as a President of a nation State? This comes especially when there is a lot of money at stake.

Another recurring idea is the use of smart contracts funded by one or both parties that automatically awards payments based on the outcome of the arbitration. But when someone is of the opinion that he shouldn’t have to pay a contracting party, why would he fund a smart contract with the risk of losing to it? Or why would someone try to win a sum he already owns?

Without an enforcement mechanism, decentralized arbitration is a paper tiger. Without a legal framework, its awards cannot be enforced in the real world. Moreover, without a guiding set of principles or governing laws, the outcomes of these systems will be even more random than the current legal systems they intend to replace.

Having said that, some innovative ideas are being proposed in the procedures, as well as the selection of arbitrators. Completely online (small) transactions or alternative forms of cooperation could perhaps benefit from such a form of arbitration. It could also provide the smaller fish in the pond access to a legal system, because a decentralized arbitration may very likely be cheaper than the traditional legal system.

Decentralized Arbitration Enforcement Framework

In order to provide a framework for decentralized arbitration, two different types of potential disputes need to be distinguished: those that require enforceability in the real world, and those that don’t.

The majority of real world transactions are small. Think about everyday purchases, small assignments, electronic products or license fees for the use of a video. For many of these transactions, there may be no need for the backing of a full-fledged legal system.

In fact, access to the conventional legal system might be too expensive and cumbersome for a dispute with a small monetary value. Such transactions could be subjected to fully decentralized arbitration instead. In terms of a legal framework, it looks like this:

However, some may not feel comfortable with a completely decentralized option. Think about a company exporting large amounts of natural gas or selling a real estate portfolio. It would need a way to enforce its rights in case something would go wrong.

As discussed earlier, a framework for enforcement already exists. It would be a very simple process to include such an arbitration process in the legal framework for international arbitration.

Moreover, the parties could consent to resolve any dispute through decentralized arbitration first. If the ruling of the decentralized arbitration system proof unenforceable, an online arbitration with physical seat could provide an enforceable ruling instead.

The complete legal framework would look like this:

In the next lesson, we look at why smart contract aren’t contracts, and what can be done to fix this.

This article is part of a series of lessons on Decentralized Law (view summary).

Cite this article

Thysse W., “Lesson 6 – Decentralized Arbitration Enforcement Framework” (Decentralized Law Lessons, December 28, 2019), available on: https://decentralizedlegalsystem.com/law/arbitration/

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