This article has been written by Jeya Suthagar A, pursuing a Certificate Course in International Commercial Arbitration and Mediation from LawSikho.
Table of Contents
Introduction
A counterclaim*, in general, is nothing but when the respondent/defendant apart from defending the claims alleged by the claimant, makes a claim seeking relief against the claimant, duly substantiated with the facts and circumstances of the case before an arbitration tribunal. It is generally a cross-action taken substantially and is seen as a ‘sword’ of offense, by which a defendant can become entitled to his claim as an independent action. The counterclaims need not essentially arise out of the same transaction of the claim.
On the contrary, a set-off* is a defense pleaded by the respondent/defendant before an arbitration tribunal arising out of the same transaction and limited to the amount originally claimed by the claimant/plaintiff. The set-off necessarily depends on the original claim and acts only as a ‘shield’ subject to the existence/ entitlement of the claim before the same arbitration tribunal.
Unlike the set-off defense, the distinctive nature of counterclaims is that apart from defense it also goes on to attack. Both the options of defense facilitate the defendant to make reciprocal claims against the claimant who had invoked the arbitration, with the advantages of mitigating the costs and time by referring to the extant arbitration tribunal instead of claiming it separately before another forum. It is for the arbitration tribunal to determine the complex issues with regard to the question of jurisdiction and governing law for permitting either counterclaim or a set-off defense.
This article aims to demonstrate the provisions available for defending the claims alleged by the Claimant by way of pleading counterclaims and set-off before international commercial arbitration. Further, this article attempts to emphasise on when a counterclaim should be preferred as a defense over a set-off defense along with their respective inherent benefits including the applicability of the doctrine of res judicata and lis pendens before the forum of international commercial arbitration
Characteristics of defense mechanism in international commercial arbitration
The choice of defending a dispute in international commercial arbitration by the Respondents/ Defendants falls under 3 distinct categories:
- A simple denial – Known as a defense statement;
- Offensive denial – Known as counterclaim(s); and
- Defensive denial – Known as set-off.
Certain arbitration tribunals have limited entertaining the counterclaims in respect of the jurisdiction of the arbitration tribunal as provided for in the arbitration agreement. Accordingly, the counterclaims fall under three different categories:
- Connected counterclaims – relating to the main claim of the Claimant.
- Compensatory counterclaims – to compensate for mutual obligations.
- Incidental counterclaims – addressing preliminary incidental issues.
The essential pre-requisites in institutional arbitration rules provide for the counterclaim to be based on the same arbitration agreement to arbitrate the disputes and the parties shall have the same contracting and legal relationship within the contract. Whereas, often the courts weigh the counter-claim and set-off as follows:
- Firstly the courts determine whether the plaintiff’s claim exists, only then the set-off shall be considered, otherwise, the set-off would be annulled. This is not in the case of the counterclaim.
- Secondly, in situations where the set-off (subject to determination by the court of the existence of the plaintiff’s claim) exceeds the plaintiff’s claim, the excess over and above the claim part can be addressed only as a counterclaim. Whereas the counterclaim needs no such condition and the same would be addressed as a whole.
A glance at counterclaim & set-off defense provisions in a few international arbitration rules
While a majority of the arbitration rules adopted internationally have explicit provisions for counterclaims, only some of them deal with set-off. This is despite the fact that the institutions also bear a striking similarity:
- The UNCITRAL Model Law on International Commercial Arbitration under Article 2(f) recognizes the counterclaim similar in lines with the title ‘claim’.
- The Arbitration and Conciliation Act, 1996 amended in 2015 in India provides for under Section 23 (2A) that the respondent in support of his case may also submit a ‘counterclaim’ or plead a ‘set-off’ for adjudication by the Arbitral Tribunal.
- The Arbitration Rules of the Singapore International Arbitration Centre (SIAC Rules) under Rule 28.5 The jurisdiction of an arbitral tribunal provides for a party may prefer a set-off defense to the extent permitted by the Rules. Article 24 of SIAC Rules provides for the right to plead set-off defence should be the subject of further scrutiny.
- Article 19(3) of UNCITRAL Arbitration Rules recognises the counterclaim and set-off arising out of the same contract for the purpose of set-off. The UNCITRAL Model law though does not have any such provision, the same was made clear in the Working Group deliberations that the jurisdiction is bound by the arbitration agreement.
- Article 42(c) of WIPO Arbitration Rules provides for counterclaim and set-off defense by the use of the word ‘any’.
- Article 21(5) Swiss Arbitration Rules 2021 provides for the jurisdiction of the Arbitral Tribunal to adjudicate even the set-off defense, which is already subject to another arbitration tribunal or court. Whereas Article 21(3) specifically reserves the possibility to object to jurisdiction over a counterclaim only.
- Article 27 of International Arbitration Rules of the Zurich Chamber of Commerce provides for Set-off exclusively similar in line with Swiss arbitration rules 2021, which now administer the Swiss Arbitration Rules.
The distinction between counterclaim and set-off defense concerning the interpretation of Article 6 no.3 of the Brussels Judgment Convention has been clearly defined by the European Courts of Justice in the matter between Danvaen Production A/S v. Schuhfabriken Otterbeck GmbH & Co. C-341-93.
Importance of arbitration agreement provisions
The arbitration agreement entered into between the parties plays a pivotal role in respect of the provisions relating to the counterclaims and set-off defense. Each arbitration agreement specifically emphasises the scope of the arbitration and the rules to be adopted by the disputing parties to refer to their corresponding claims and counterclaims/ set-off, with specific reference to the choice of law agreed to be adopted.
The jurisdictions of the arbitral tribunals are based on the intentions of the parties as agreed to in the respective arbitration agreements and hence are consensual in nature.
Set-off defense before arbitration
In general, the arbitration laws very rarely provide for rules on set-off. The set-off signifies a substantive defense by denying the claim of the claimant/ plaintiff before an arbitration tribunal and hence the same is generally admissible, even without a specific proviso. While set-off in international arbitration has been seen more commonly as a defensive approach, in case the arbitral tribunal does not have the jurisdiction to entertain the counterclaim, the set-off defense is the best immediate available alternative. The claim for set-off exists as a ‘reserve option’ in situations, where the defendant acknowledges the fact that the claimant’s claim exists, however, the same is extinguished by way of compensation due to the defendant by way of set-off against the claimant/plaintiff.
Set-off is often treated differently in the civil law and common law jurisdictions viz., in civil law jurisdiction, set-off is treated as a matter of substance, while in common law jurisdictions, it is considered as procedural character. The defendant possesses the option of set-off defense before arbitration in situations, where the counterclaim is beyond the competencies of the tribunal as per the arbitration agreement between the parties to the dispute. The set-off concept is principally based on the fundamental principles of equity, justice & good conscience.
The United Nations Commission on International Trade Law (UNCITRAL), at its 14th session (1981) decided to assign its Working Group with the task of preparing a draft model law in the field of international commercial arbitration. The Working Group considered that the provisions that are applicable for the counterclaims would also apply mutatis mutandis to a claim which is relied on by the respondent/ defendant for the purpose of a set-off as well.
Klaus Peter Berger, a German Jurist notes that the intent behind the requirements for filing a set-off defense and the nature of decisions are similar to that of the counterclaim. However, set-off is limited to the amount claimed by the plaintiff, which represents a limitation in its scope, when compared to that of the counterclaim. In these situations, the defendant may have to seek claim of the remaining portion either before another arbitration tribunal or before a court, as may be applicable. The issue of connexity is rarely an issue in case of set-off, when compared to that of the counterclaim, which has its independent legal purpose.
Further K.P.Berger stated the set-off and counterclaim are only a ‘hair’s breadth away’ in international commercial arbitration since both may be resting on similar factual background, viz., reciprocal debts of the defendant against the claimant, in fact, the intended relief and the nature of decisions are also similar in nature. For this reason, a set-off defense is often called a ‘counterclaim in disguise’.
While a set-off defense is normally raised by a respondent in arbitration, the Claimant/ Plaintiff also can raise a set-off against a counterclaim raised by the Respondent/ Defendant. Thus in international commercial arbitration, the possibility of set-off is commonly invoked as a general principle of international commercial law.
New swiss arbitration rules
Switzerland represents one of the favourite arbitration destinations in international commercial arbitration for its uniqueness. The Swiss Rules of International Arbitration (“Swiss Rules”) were enacted on 1st Jan 2004, after a long span of time the rules were revised for the first time on 1st June 2012. Following which, a trivial revision was made on 1st June 2021. The importance of Swiss Rules of International Arbitration could be revealed from the six Swiss arbitral institutions namely Basel, Geneva, Bern, Lugano, Lausanne and Zurich adopting uniform Swiss Rules concerning international disputes. The Swiss Rules of International Arbitration primarily is based on UNCITRAL Arbitration Rules which has been drafted in association with the Swiss Arbitration Association (“ASA”).
For the purpose of administering the arbitration, the Swiss Chambers Arbitration Institution (“SCAI”) was founded by the Chambers of Commerce, which was later converted and renamed as Swiss Arbitration Centre Ltd. (“Swiss Arbitration Centre”), with effect from the same date, when the new Swiss rules came into effect i.e. 1st June 2021. The 2021 revision aimed at providing a more efficient and reliable framework for arbitral proceedings around the world. Presently the Arbitrations under the Swiss Rules are being administered by the Arbitration Court (the “Court”) of the Swiss Arbitration Centre.
The new Swiss rules are applicable to all arbitration proceedings, where the Notice of Arbitration is served on or after 1st June 2021, with the provision in the arbitration agreement referring to the administration of the disputes by SCAI or the Swiss Arbitration Centre.
Analysing the Swiss Rules
A remarkable feature of the new Swiss Arbitration Rules is with regard to the extent of the jurisdiction of the Arbitrator to hear a set-off defence in situations involving if the defence has arisen beyond the scope of the arbitration clause or in situations where the defence falls within the scope of another arbitration agreement as embodied in Article 21(5) of the Swiss Rules. As the set-off defense principally aims to deny the very existence of the original claim, the set-off is of similar quality to any other substantive defense, the Arbitral Tribunal shall therefore have jurisdiction to decide on all sorts of defences raised against the claim. The inclusion of this feature is based on the principle of “Judge of the action, judge of the exception” according to which, the Judge who is competent to decide on legal actions is also competent to rule on the exception as well, known in French law as “Le juge de l’action est le judge de l’ exception”. This applies even in situations where the question of the rule of exception has been left to another tribunal or judge. Article 21(5) of Swiss Rules provides for the extent of the jurisdiction on the arbitral tribunal to deal with the ‘set-off defense’ which reads:
“The arbitral tribunal shall have jurisdiction to hear a set-off defence even when the relationship out of which this defence is said to arise is not within the scope of the arbitration clause or is the object of another arbitration agreement or forum-selection clause.”
It becomes evident from the above that the drafters of the new Swiss Arbitration Rules had primarily considered the ‘procedural economy’ keeping in mind the importance of express agreement made between the parties in the Arbitration Agreement. The extent of jurisdiction of the Arbitrators to deal with the set-off defense as articulated in Article 21(5) poses serious legal infirmities, which includes whether the jurisdiction of the Arbitral Tribunal is to be established or merely the provision permits automatically, whether the set-off defense should be construed in the stricter or broader meaning and the likely impediments that may arise out of this controversial provision.
The wordings of Article 21(5) resembles that the provision is imperative in nature. However, there is room for the invocation of doctrine forum non-conveniens unless the seat of the Arbitration is located in a common law country. Treating the provision of Article 21(5) as discretionary may have repercussions while enforcing or setting aside an award, wherein a court may find that the application of procedure of Article 21(5) to be not in accordance with the arbitration agreement as provided for under Article V (1) (d) of the New York Convention.
As the scope of application of Article 21(5) extends into other arbitration clauses or forum clauses, any unconditional application of it may result in potentially conflicting decisions of two arbitration tribunals or courts, which may have long term consequences on the procedural economy. Another ambiguity that may arise in respect of set-off defense is when the set-off exceeds the claim of the plaintiff, wherein the defendant shall have to deal with a set-off defense before one arbitration tribunal and for the excess or remaining part of the claim with another Tribunal, which is practically illogical. Moreover, this also paves way for the claimant to invoke Swiss Arbitral Award as res judicata and follow its consequences. This would create confusion and ultimately delay the arbitral proceedings by the second Arbitral Tribunal, awaiting the recognition or refusal of the award, which had dealt with set-off defense. The defense invoking lis pendens under Article 9(1) of Swiss Private International law In cases of parallel arbitral proceedings is also uncertain and is likely to be rejected on the principles of kompetenz-Kompetenz, which enables the arbitration tribunals to assess their jurisdiction independently.
As explained above, the two important factors that may lead to likely complications include the existence of the forum selection clause or arbitration clause, which covers the relationships based on which the set-off defence arises and the amount of respondent’s claim when it is in excess of the claim of the Claimant makes the procedural economy argument meaningless. The arbitral tribunal or the Court decides on an issue parallelly attracts the applicability of res judicata on the effect of arbitral awards & lis pendens before international commercial arbitration.
Decision on set-off as res judicata
Almost in all legal systems, the doctrine of res judicata exists. However, the different legal systems deal differently with regard to how they distinguish the positive and negative aspects of res judicata and its impact on the procedure. Res judicata includes only the holding in the continental systems. While in the common law systems in France, the Netherlands, Belgium and Switzerland, the effect of res judicata is extended to ratio decidendi and to understand the scope of the holding, in addition, it also recognizes the doctrine of ‘estoppel’.
The scope of res judicata depends on the law of the country of recognition of a foreign decision. The foreign court decisions render less effect than the domestic court decisions meaning that res judicata effect will be only to the holdings. While in the cases of arbitration, if res judicata is to be represented, a foreign decision must undergo a formal recognition process in the country of the seat of arbitration. In case such recognition is not available, the decision of another tribunal or court need not be considered by the arbitration tribunal. With regard to the applicability and operation of another arbitral decision, the arbitral tribunals have in fact seldom applied either standards of country of the seat of arbitration or applicable substantive law.
Thus, a decision on set-off defense by Swiss Arbitration will be binding if passed by another tribunal, only when the Swiss award could be recognised in the country of the seat of the respective other arbitration tribunal. While holding an arbitral award encompasses normally a statement on the existence and the value of the counterclaim. Hence the applicability of res judicata will hardly present any difficulty.
Parallel deliberation on the set-off defense
The wording of Article 21(5) by itself exemplifies parallel deliberation on the set-off defense, with the proviso that ‘……..is the object of another arbitration agreement or forum selection clause’. The intent of Article 21(5) offers the possibility of two tribunals to parallelly deliberate the set-off defense leading to legal questions in respect of applicability of lis pendens rules or examination of a tribunal’s jurisdiction on its own ignoring the arbitrations that may be initiated elsewhere.
The new Swiss Arbitration rules 2021 and the decision reached by Swiss Federal Supreme Court dated 14th May 2001, in the matter between Fomento de Construcciones y Contratas S.A. v. Colon Container Terminal S.A held that the arbitration tribunal shall apply the lis pendens rules of its situs, in order to determine the indirect jurisdiction whether the other tribunal or court has jurisdiction. The indirect jurisdiction can be assessed by the system of bilateralisation or by a liberal position where indirect jurisdiction always subsists, except when the issue falls within the exclusive competence of domestic judiciary.
The parallel deliberations are inevitable when the arbitral tribunal adopts the lis pendens rules from the lex arbitri treating its own jurisdiction as exclusively based on the arbitration agreement. Whereas the intent of exclusive jurisdictions provides for no regard is to be given to competence of another tribunal or court. Thus if a Swiss arbitration faces another arbitral tribunal, the conflict of the jurisdictions has to be solved, whereas there won’t be any flexibility in case the Swiss arbitration tribunal is facing a court.
The tribunals dealing with set-off defense may consider their competence as ‘relatively exclusive’ or ‘concurrently exclusive’, which are contradictio in adjecto, the scope of Article 21(5) clarifies that both the tribunals are considered on equal footing. Both the tribunals are entirely competent to hear and decide the issue of counterclaim raised for the purpose of a set-off defense raised before a Swiss arbitration. Thus, in the spirit of international arbitration the party first raising a counterclaim in effect would determine the arbitral tribunal to be exclusively competent to decide.
Case laws
- European Courts of Justice in the matter between Danvaen Production A/S v. Schuhfabriken Otterbeck GmbH & Co.C-341-93 clearly illustrated the difference of counterclaim and set-off.
- ICC Case no. 3540, 3rd October 1998 distinguishes the law applicable based on merits of self defense and the procedural admissibility of set-off. The Award also suggested that “according to the general principles of law, non-contractual set-off is subject to four cumulative conditions: identical nature of performances, similarity & reciprocity of the subjects, the claims should be certain, liquid, and finally maturity of the claims (i.e. not to be subjected to time limit).”
- In a fundamental decision dated 14th May 2001, the Swiss Federal Supreme Court, in the matter between Fomento de Construcciones y Contratas S.A. v. Colon Container Terminal S.A, held that the arbitration tribunal shall apply lis pendens rules, as in most of the countries, the principle of lis pendens has been well established and it applies equally in the arbitration proceedings governed by the Swiss Arbitration Act.
- The ICC Case no.2745/2762, 1977, Paris 1990, Page 326 relates to the application of res judicata in regard to the scope of operation of decision of another arbitration tribunal, where the arbitral tribunals have applied standards of country of the seat of Arbitration.
- The ICC Case no.3267/ 1984 (1987) XII relates to the application of res judicata in regard to the scope of operation of decision of another arbitration tribunal, where the arbitral tribunals have applied standards of applicable substantive law.
Conclusion
The defendant’s counterclaim raised for the purpose of set-off defense operates differently in international commercial arbitration when compared with that before the court for principal reasons of establishing the jurisdiction of an arbitral tribunal over a counterclaim and set-off which is more difficult by testing the objective reach of an arbitration agreement. Whereas the jurisdiction of court results in ‘attraction of procedures’ a party has commenced in the competent courts. Unlike the procedure in courts, the attraction of procedure conditions is harder to reach in arbitration.
In view of the above, the introduction of the new Swiss rule by which the tribunal may decide a set-off defense, even if it is subject to another arbitration clause or forum selection clause appears to be complicated. In general, the arbitration tribunals rely on the principle of Kompetenz-Kompetenz contained in the respective arbitration agreements. In case of any doubt or ambiguity in respect of the scope of jurisdiction, the scope of other arbitration agreements or forum selection clauses may represent similarities or overlap of jurisdictional aspects. Article 21(5) of the Swiss rules aims for the improvement of procedural economy and provides for the Arbitral tribunal to ignore the scope of other arbitration agreements or forum selection clauses.
Further, Article 21(5) of Swiss arbitration rules removes all the arguments in view of potential lack of jurisdiction by providing legal certainty, which is contrary to the provisions of Article 19(3) of UNCITRAL Arbitration Rules. Conclusively Article 21(5) of Swiss rules has broadened the jurisdiction of the arbitral tribunal and made it certain that the right of set-off defense irrespective of its origin would be admissible. The provisions introduced in the new Swiss arbitration rules are quite firm, straight-forward, clear and are inevitable. Thus a Swiss tribunal will not have any discretion in asserting jurisdiction over a set-off defense. Therefore the 2021 revisions made in the Swiss rules are seen by large, as welcome amendments, which apart from maintaining the key provisions and the spirit of the instrument intact has organized the existing practice and modernized the Rules.
The conception of the centralised “Swiss Arbitration” online platform is likely to increase the accessibility of resources for foreign countries and the efficiency, by continuing to maintain in an increasingly competitive field, with the position of Switzerland as the leading seat and venue for international arbitration. The latest revisions and refinements made in 2021 are audacious in international commercial arbitration and are expected to enhance the contributions of Swiss arbitration rules for further development of international arbitration. The concrete steps adopted in the new Swiss arbitration rules not only help to maintain its competitiveness with other arbitral institutions, but also motivates the other institutions and locales to consider optimizing and modernizing their rules and legislation.
References
- Swiss Rules of International Arbitration, www.swissarbitration.org/centre/arbitration/arbitration-rules.
- https://www.researchgate.net/publication/228159838 “Counterclaim and Set-Off in International Commercial Arbitration”
- “Set-off in International Economic Arbitration” by Klaus Peter Berger, Arbitration International Volume 15, No.1, LCIA 1999.
- Vladimir Pavic, “Jurisdiction of an Arbitral Tribunal over set-off under Swiss Rules of International Arbitration” – ASA Special Series No.44, JurisNet, LLC 2014.
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