Should corporate disputes be subject to mandatory arbitration? Over the last decade, the debate relating to implementing mandatory arbitration provisions in a firm’s articles or bylaws has been highly controversial. Litigation is problematic for some companies due to the increased volume of lawsuits and higher settlement amounts, the costs of which are ultimately borne by shareholders. However, corporate litigation can uncover information and, thereby play an important role in the effective monitoring of corporate behavior. In the context of this important debate, relatively little is known about institutional investors and companies’ preferred method of dispute resolution. In our paper, ‘Mandatory Arbitration of Intra-corporate Disputes: A Beacon on Light for Shareholder Litigation?’ we use a unique dataset to examine the factors that affects parties’ choice for a dispute resolution method.
Policymakers around the world have reacted differently to mandatory arbitration of shareholder claims. In Italy, for example, the enforcement of arbitration agreements of listed companies or companies with diffused shares is prohibited. Similarly, the United States Securities and Exchange Commission (SEC) has again recently opposed the inclusion of an arbitration provision in the corporate documents of listed companies. To be sure, some regulators show clear signs of favoring mandatory intra-corporate arbitration. For example, Brazil has perhaps the most open attitude towards arbitration for intra-corporate disputes, mandating it as a prerequisite for registering in specific listing segments.
There are two competing views in the prior literature. On the one hand, a number of papers have focused on bylaws and corporate charters as binding contracts between the company and its shareholders, arguing for the validity of mandatory arbitration provision in the referred corporate documents. In contrast, a second line of papers suggests that the fiduciary doctrine should apply as a response to the natural disadvantage of minority shareholders, in terms of both their expertise and ability to access evidence and bargain effectively and whether corporations can adopt bylaws that provide for mandatory arbitration of shareholders’ claims.
In the absence of data on the mechanisms at the institutional level, we use a survey to elicit company and investor views on intra-corporate dispute resolution. In our first survey conducted in third quarter of 2017, we asked Brazilian law firms, corporations, limited liability companies and small and medium-sized companies about their choice of dispute resolution mechanism. We also conducted an additional survey between January and March 2019 to obtain information on the preferred method of dispute resolution of institutional investors with stakes in Brazilian companies.
We begin by examining parties’ preferred method of intra-corporate dispute resolution, and whether there is variance in these preferences depending on the value involved in the dispute. Prior literature shows that the amount at stake is likely to play an important role in the choice of method. We find that most respondents in our 2017 survey sample preferred arbitration over other forms of dispute resolution, and that preference increased as much as 10.53 percent whenever disputes involve values higher than US$ 12.5 million. In addition, we show that only 14.04 percent of respondents believe that arbitration is rarely or never appropriate for intra-corporate dispute resolution, while 47.37 percent of the respondents believe that arbitration is always or often appropriate. For the 2019 survey, we examine whether arbitration is the preferred choice of institutional investors for disputes involving up to US$ 2.5 million. The amount involved is important for our analysis here. Consistent with our expectations, we find that the parties’ preferences vary according to the dispute value, and that mediation or conciliation is the preferred method of intra-corporate dispute resolution when the values involved are lower than US$ 2.5 million. We show that there is an almost equal preference among institutional investors for mediation or conciliation and arbitration to solve intra-corporate disputes involving values higher than US$ 2.5 million. In sum, our results show that quality of the decision, time to resolution and costs are the most important factors affecting the selection of dispute resolution methods.
Next, we examine whether mandatory arbitration provisions should be included in shareholders’ agreements. For the 2017 survey, we find that 49.12 percent of the respondents believe that mandatory arbitration should be binding when included in shareholders’ agreements about dispute resolution. It is worth noting that 38.60 percent of respondents believe that mandatory arbitration, even when included in shareholders’ agreements, should not be binding either to minority shareholders or to both minority and majority shareholders. The results suggest that respondents are divided on whether mandatory arbitration clauses should be included in shareholders’ agreements. Interestingly, we show that less than half of the institutional investors (43.13%) thought that arbitration should be mandatory. When asked to select the main factors for choosing arbitration, most investors indicate time to resolution, quality of the decision and selection of arbitrator as the top reasons for choosing arbitration. Notably, confidentiality and predictability also appear to be important drivers.
Next, we examine how institutional investors react to advice from law firms with respect to the arbitral process. Prior studies show that the most important legal advice tends to involve technical industry knowledge and expertise in the arbitral process. Consistent with our dispute resolution results, institutional investors find that legal fees and expenses are the most significant expenses in intra-corporate arbitration procedures. Moreover, we show institutional investors find experts’ fees and expenses less problematic in an arbitral proceeding.
Overall, we find that a majority of respondents to both surveys prefer arbitration over court litigation as a method of intra-corporate dispute resolution. Our analysis sheds light on the importance of the increasing popularity of mandatory intra-corporate arbitration. This paper contributes to the growing literature on arbitration’s role in encouraging an effective redress for shareholders and reducing shareholder litigation. Our study shows that arbitration is perceived as an effective procedure in Brazil for intra-corporate dispute resolution and offers increased benefits to parties enforcing arbitration provisions.
Patricia Gil Lemstra is a PhD Candidate at the Tilburg Law School.
Joseph A. McCahery is Full Professor at the Tilburg Law School.