Originally from Soft Law in International Arbitration, Second Edition

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INTRODUCTION

Once arbitrators have made a determination as to liability they have considerable discretion in assessing damages. Although arbitration rules contain provisions referring to such elements of relief  as costs and interest, they say nothing about damage determinations. The parties may, however, have imposed limits in their arbitration clauses by ruling out the awarding of certain types of damages, such as consequential or punitive, and they may prescribe limitations on the amounts of damages that may be awarded. But, in the absence of such contractual guidance, arbitrators are left to determine, through the application of their own standards (assuming no overriding public policy or legal standards), the nature and extent of the damages they award. The purpose of this Protocol is to provide guidelines for arbitrators in making damage determinations.  

The determination of damages is important and should be done with considerable care by arbitrators. Therefore, arbitrators should, in their award of damages, apply a consistently reasoned approach and procedures that are fair, efficient and not overly costly.

 1. DAMAGES EVIDENCE

Some kinds of damages are relatively easy for arbitrators to assess. For example, if a contractor fails to complete a job at a fixed price and a replacement contractor is hired to complete the work, the difference between the cost of the second contractor – assuming the charges are reasonable–and the price agreed on by the first contractor constitutes the damages, together with the incidental costs of finding and hiring the second contractor. As another example, if the dispute between the parties is whether certain new products sold by the respondent are within or outside the terms of a license agreement between them, there may be a contractually specified formula for determining the royalties owed once coverage determinations are made. 

On the other hand, some breaches of contractual commitments give rise to greater uncertainty as to the appropriate level of damages. A claimant may seek damages based on what would have happened in a hypothetical world in which the breach or wrongful activity did not occur. For example, contracts for the acquisition of a business often produce claims by the buyer based on breaches of warranties, or even fraudulent inducement, in which damages are sought for the difference between what was expected in terms of future earnings and what was obtained. Similarly, acquisition agreements with earn-out provisions often generate claims by the seller that the buyer failed to operate the business in the contractually specified manner during the earn-out period, giving rise to asserted damages for the difference between what was actually earned and what should have been earned. Claims can also arise where capital goods, process controls or business methods fail to perform as advertised.

In such cases, the arbitrators are requested to make determinations of what might, or should, have happened but did not. Determining damages in these cases involves at least two important considerations: the assumptions that are to be made as to what might have happened and the models that are to be used that will lead to the assessment of the appropriate level of damages.