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Arbitration clauses in contracts

Do you even want an arbitration clause?

Before including an arbitration clause in a contract, consider the pros and cons. A useful summary of many of the “cons” can be found in an August 2009 article by Anthony C. Valiulis and Cassandra M. Crane, Winning the Battle to Arbitrate: Was the Victory Real or Pyrrhic? (accessed Sept. 23, 2009).

Deciding what types of dispute should be arbitrated

• The classic formulation in an arbitration clause is that “all disputes arising out of this Agreement will be arbitrated . . . .”

• A more-expansive version is “all disputes arising out of or relating to this Agreement will be arbitrated . . . .”

• Some arbitration clauses provide that “all disputes arising out of or relating to this Agreement or any transaction or relationship resulting from it will be arbitrated . . . .”

The last variation is adapted from an arbitration clause upheld by the Fifth and Eleventh Circuits in two cases involving a mortage-loan servicing company that was sued by a homeowner. In those cases, the loan agreement contained an arbitration clause. The mortage service company had not signed the loan agreement, but moved to compel arbitration anyway. Both the Fifth and Eleventh Circuits agreed that the homeowner was bound by the arbitration clause because it applied to “[a]ll disputes, claims, or controversies arising from or relating to this Agreement or the relationships which result from this Agreement ….” Sherer v. Green Tree Servicing LLC, No. 07-60567 (5th Cir. Nov. 10, 2008) (reversing denial of motion to compel arbitration), citing Blinco v. Green Tree Servicing LLC, 400 F.3d 1308, 1310 (11th Cir. 2005).

Preempting state arbitration prerequisites by invoking the Federal Arbitration Act

It may be important to recite expressly that the agreement to arbitrate is subject to the Federal Arbitration Act. If such an agreement is in fact subject to the Act, then failure to comply with state-law requirements for conspicuous notice, etc., that apply only to arbitration provisions, may well be preempted by the Act. See generally, e.g., Doctor’s Associates, Inc. v. Casarotto, 517 U.S. 681 (1996) (reversing, on preemption grounds, Montana Supreme Court ruling that arbitration clause was unenforceable for failing to comply with a Montana law that required contracts containing arbitration provisions, but not other contracts, to include a specific notice on the first page).

Arbitrating non-contractual claims that may arise

An arbitration clause might cover “all other claims, of whatever nature, that may arise between the parties.”

A similar such clause was enforced by the Eighth Circuit in Industrial Wire Products, Inc., v. Costco Wholesale Corporation, No. 08-3189, slip op. at 2 (8th Cir. Aug. 6, 2009). In that case, a vendor sued its customer Costco for patent infringement because Costco also sold competing products obtained from a different vendor. (Now there’s a brilliant move, guaranteed to promote future sales ….)

Costco’s vendor agreement, however, included an arbitration provision that said, among other things, that “this agreement to arbitrate covers, without limitation, any claims with respect to matters relating to the distribution rights of any of the parties arising under this Import Agreement or any applicable law.”

The district court denied Costco’s motion to compel arbitration, but the appellate court reversed, holding that, interpreted liberally (as required by the applicable state law), the quoted language encompassed the vendor’s claims against Costco. See id., slip op. at 8-9.

Arbitrating disputes about arbitrability

Regularly, parties to a dispute disagree about whether the dispute is arbitrable, or whether it must instead be decided by a court. In theory, an arbitration clause can resolve that question in advance: “The United States Supreme Court has stated that the question whether the parties agreed to submit a particular issue to arbitration (i.e., the ‘question of arbitrability’) is for the court to decide unless the parties ‘clearly and unmistakably’ agreed otherwise.” Sanchez v. Western Pizza Enterprises, Inc., No. B203961 (Cal. App. 2d Dist. Mar. 17, 2009), at 10 n.3 (citations omitted).

In September 2009, however, the majority of a panel of the Ninth Circuit ruled that a court, not the arbitrator, must decide any unconscionability challenge to the arbitration clause. See Jackson v. Rent-A-Center West, Inc., No. 07-16164 (9th Cir. Sept. 9, 2009) (reversing order dismissing complaint and compelling arbitration). [ADDED 2009-12-24]

Arbitration rules: Which ones to specify

The AAA Commercial Arbitration Rules seem to be a typical “default” standard. The AAA also has expedited rules that can be used if desired.

Some believe that the ICC arbitration rules of the International Chamber of Commerce are among the most popular world-wide. Still others view the UNCITRAL rules as holding that position. (This article compares the latter two.)

Then there are the rules and expedited rules of the World Intellectual Property Organization.

See generally the arbitration-clause checklist by my late partner, friend, and mentor, the legendary intellectual-property lawyer Tom Arnold.

One arbitrator, or three?

Folk wisdom among litigators is that the cost of three arbitrators is likely to be rather more than three times the cost of a single one.

Three arbitrators will need extra time for conference calls, exchanging and commenting on drafts, etc.

A multiple-arbitrator panel is also likely to need more calendar time than a single arbitrator to get things done.

Selecting the arbitrators

Most arbitration “providers” (e.g., the AAA) maintain lists of arbitrators who putatively have experience in particular areas such as technology, employment disputes, etc.

In cases where three arbitrators are to be appointed, a typical approach is for each party to appoint a “party arbitrator,” and then for the party arbitrators to jointly appoint a “neutral” arbitrator.

Place of arbitration

The place of arbitration (sometimes called the “seat” of the arbitration) could have significant implications for the governing law and the enforceability of any eventual award, especially if the place of arbitration is not a signatory to the New York Convention.

For a review of some pros and cons of choosing London as the seat of international arbitration, as opposed to New York, Singapore, or Bermuda, see this 2008 interview, in The Metropolitan Corporate Counsel, with two lawyers in Weil Gotshal’s London office (accessed Oct. 13, 2008).

Self-administration of arbitration proceedings

The AAA arbitration rules, among others, provide that the AAA will administer the arbitration, for a fee of course.

In theory, self-administered (“ad-hoc”) arbitration under one or another set of standard rules might be less expensive.

In practice, however, the savings might well be offset by the arbitrators’ billings for administrative work that would normally be handled by the institutional administrator.

Moreover, if a procedural dispute were to arise, having a neutral administrator available to resolve the dispute is often well worth what is usually a modest administration fee.

(Disclosure: My view on this issue is informed by that of my wife, a labor- and employment arbitrator.)

Heads-up – unequal access to courts

Parties opposing arbitration have sometimes attacked arbitration provisions allowing only one party to pursue judicial remedies (e.g., to protect confidential information or other intellectual property rights).

Generally, such parties claim that this amounts to unequal access to the courts, and that the arbitration provision is therefore procedurally unconscionable. See, e.g., Zimmer v. CooperNeff Advisors, Inc., 523 F.3d 224 (3d Cir. 2008) (vacating and remanding denial of motion to compel arbitration).

Heads-up – litigating can waive right to compel arbitration

A party that chooses to pursue litigation can find itself having waived its right to compel arbitration.

In the Zimmer case cited above, on remand the trial court provided a useful catalog of factors weighing for and against a finding of waiver before concluding that the former employer had not waived its right to arbitration. See Zimmer, No. 04-03816 (E.D. Pa. Sept. 26, 2008) (granting motion to compel arbitration).

For another useful overview of authorities, see Nicholas v. KBR Inc., No. 08-20140 (5th Cir. Apr. 15, 2009) (affirming denial of plaintiff’s motion to compel arbitration after having litigated in court for ten months).

Preliminary injunctions

Parties should keep in mind that (1) preliminary injunction hearings can be extremely expensive because of the intense trial-like preparation packed into a short time; and (2) as a practical matter, the outcome of a preliminary injunction hearing might force one side or another into an undesirable settlement.

Chapter 22.IV.A of the Proskauer treatise (accessed Oct. 13, 2008) has a useful discussion of preliminary injunctions in the arbitration context.

Amiable compositeur, etc.

Generally speaking, an arbitration panel acting as amiable compositeur or ex aequo et bono may set aside what might be called ‘technical considerations’ of the law, and instead may issue an award it deems just. This is roughly analogous to the way a court of equity might decide a case.

In many jurisdictions, however, an arbitration panel is not permitted to act in this way unless expressly authorized by the arbitration agreement. See, e.g.:

Consecutive-day hearings

An arbitration agreement can require that the hearing be conducted on consecutive days. (This was another Tom Arnold suggestion.)

Any courtroom litigator can confirm that cases take longer and cost more to try when the judge doles out his or her time a few hours here and a few there. The same is almost certainly true for arbitration proceedings.

Keeping the arbitrators together till they finish the award

Here’s another Tom Arnold suggestion: In a proceeding having multiple arbitrators, require them to stay together until they finish their award — that will hold their feet to the fire to get their work done so that they can go home.

Enhanced appellate review might be prohibited

In March 2008, the U.S. Supreme Court ruled that, when the sole authority for an arbitration proceeding is the Federal Arbitration Act, the parties cannot agree to judicial review of the award except on the limited grounds provided in the Act. See Hall Street Assoc. v. Mattel, Inc., No. 06-989 (U.S. Mar. 25, 2008).

The Court, however, left open the possibility that enhanced review might be available under some other authority, such as state law or (in the case of court-annexed arbitrations) a court’s inherent power to manage its docket.

Later that year, the California Supreme Court accepted the Court’s invitation: It ruled that, under the California Arbitration Act, the parties to an arbitration agreement can indeed agree to enhanced review. See Cable Connection, Inc. v. DIRECTV, Inc., No. S147767 (Cal. Aug. 25, 2008) (reversing and remanding court of appeals’s reversal of district court’s vacating of arbitration award).

If parties are amenable to enhanced judicial review, they might want to limit review of the arbitration panel’s findings of fact, on grounds that the arbitration panel’s expertise in the subject matter is likely to be greater than that of (literally) a random judge.

At this writing, in recent months both the trial bar and consumer interest groups have been urging a revision of the Federal Arbitration Act to make it easier for consumers to go to court against businesses instead of being forced into arbitration. It would not be surprising if, as part of such a revision, Congress might amend the Federal Arbitration Act to allow parties to agree to enhanced judicial review of arbitration awards, along the lines described in this clause.

International arbitration

For a useful general overview of international arbitration, see chapter 19 of the Proskauer international-ADR treatise.

In consumer contracts, arbitration clauses can be dodgy things

Contract drafters need to be careful in drafting arbitration clauses if the parties have unequal bargaining power — especially where consumers are parties. If a judge can be persuaded that an arbitration clause is substantively- or procedurally unconscionable, or fails to comply with a state-law notice requirement, s/he might invalidate the arbitration clause and force the parties into litigation.

Corporations don’t often arbitrate among themselves

Oddly, a 2007 study indicated that

Over three-quarters of the studied companies’ consumer agreements provided for mandatory arbitration of disputes. Yet less than ten percent of their negotiated nonconsumer, non-employment contracts included arbitration clauses.

The absence of arbitration provisions in the great majority of negotiated business contracts suggests that companies value, even prefer, litigation as the means for resolving disputes with peers.

Theodore Eisenberg, Geoffrey P. Miller, & Emily L. Sherwin, Arbitration’s Summer Soldiers: An Empirical Study of Arbitration Clauses in Consumer and Nonconsumer Contracts, Cornell Law School Legal Studies Research Paper No. 08-017, at 6, Dec. 18, 2007 (extra paragraphing added), discussed in Jonathan D. Glater, Companies Unlikely to Use Arbitration With Each Other, New York Times, Oct. 6, 2008, each accessed Oct. 6, 2008.