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A Practical Guide to Avoiding Pitfalls in Drafting Arbitration Provisions.

Byline: Jill R. Johnson

It is no surprise that, for many businesses today, a jury trial is considered something that should be avoided. Jury awards can be both unpredictable in size and scope, and can appear to bear little relationship to the legal issues presented by a case or the actual damages claimed. Litigation is also a public forum, where most if not all of the documents filed in the case become a matter of permanent public record. Many businesses do not want items such as contract terms or other commercially-sensitive information (which is often the subject of a dispute) available for public inspection.

As a result, in recent years, many companies have been retreating from the uncertainties of a dispute resolution process based on the jury trial. Instead, the avenue now sought by many businesses is an arbitration-based dispute resolution system, in which individuals with experience in the particular area of the dispute hear and decide the issues. This alternative system is a private process that is based on arbitration agreements in contracts, such as commercial agreements or employment agreements, which require that all or most disputes arising out of the contract be resolved by binding arbitration. Although mandatory arbitration may look like a favorable alternative to litigation, in order to get to the point of actually arbitrating a dispute, the arbitration agreement at issue must actually be enforceable. A poorly drafted arbitration agreement can derail the parties' desire to avoid litigation and can result in the parties being forced to litigate their dispute in a courtroom -- despite the fact that neither party likely wanted such a result.

This article will address several common drafting mistakes that may lead to an arbitration agreement being deemed unenforceable, and will discuss several essential elements that all arbitration agreements should contain in an effort to help businesses (and the in-house attorneys who often review or draft the contract provisions in question) avoid pitfalls to ensure that the parties' intentions are carried out.

Essential Element -- Mutuality

As a basic starting point, an arbitration provision, like any other contract, must be supported by valid consideration. Often this means that the arbitration agreement must be a mutual agreement to arbitrate, made by both parties. Thus, an arbitration agreement that is one-sided, in that it requires only one party to submit disputes to arbitration while the other party is free to pursue its claims in litigation, is not mutual and is therefore likely unenforceable in many states.

Essential Element -- Neutrality

Some arbitration provisions will also attempt to give one party (usually the party with the most bargaining power) the sole and exclusive right to control the list of potential arbitrators, the location of the arbitration, etc. However, courts have held that this type of unilateral control over the process by one party renders the arbitration provision invalid and unenforceable. Instead, the provision should provide for a process by which arbitrators are to be selected and should involve both parties. For example, a common type of arbitrator selection provision provides for a three-arbitrator panel, with each side selecting one arbitrator and those two arbitrators selecting the third or with the third being appointed by the applicable arbitration organization. The parties should also agree on the location of the arbitration beforehand, and the location should be specifically identified in the provision.

Essential Element -- Specificity (But Not Too Much)

Ambiguous or subjective words like "may" or "believes" should also be avoided. It seems like an extreme example, but a clause which provides that, "The parties shall agree to arbitrate so long as one party believes arbitration will be effective," is plainly not enforceable.

However, be careful to avoid the other extreme and include overly specific requirements, particularly regarding the arbitrators' qualifications (providing that an arbitrator must speak French and Chinese and be familiar with the nuances of the electricity market, for example). There may be no arbitrator who fits this profile, which can cause procedural issues with the enforceability of the provision, at worst, and delays, at best.

Essential Element -- Waiver of Right to Jury Trial

To avoid confusion regarding the selection of the parties' method of dispute resolution, the arbitration provision should also clearly state that, by agreeing to arbitrate, the parties are clearly and unequivocally waiving their right to seek relief in a judicial forum. Courts have consistently held that absent some reflection in the arbitration provision of the parties' basic understanding that they are giving up their right to use the court system to litigate disputes that arise between them the provision will be unenforceable.

This is particularly true in the context of a contract between a company and an individual, such as an employment agreement, where there might be the appearance of a disparity of sophistication between the parties. There is no "magic language" that has to be used to convey this understanding; however, language to the effect of, "The parties to this agreement give up their rights to have claims and disputes arising under this contract heard and decided in a court of law" is likely sufficient.

Essential Element -- Appropriate Limitations Period

It can also be tempting to include in the arbitration agreement language that requires parties to submit any claims to arbitration within a certain (often fairly short) timeframe (30 days, for example) from the date the claim or dispute arose. Oftentimes, this results in the parties having a shorter time within which to bring their claim in arbitration than they have under the applicable statute of limitations governing the claim if they were to pursue the claim in litigation. In some states, this attempt to create what amounts to a private statute of limitations between the parties is per se unenforceable; however, in other states, a private statute of limitations may be enforceable unless it is unreasonable. It is therefore important to know what law will govern your arbitration agreement and draft any provision setting a deadline for bringing a claim accordingly.

Doing It Right.

At its core, an arbitration provision should do four basic things: (1) define the scope of the claims that the parties want to be able to submit to arbitration; (2) commit the parties, unequivocally, to arbitration as the sole method of resolving those claims; (3) determine a set of rules and parameters to govern the arbitration processes, such as the selection of arbitrators, the place of arbitration and the like; and (4) provide for the entry of judgment by a court following the ruling by the arbitrator(s).

With a carefully drafted and enforceable arbitration agreement, businesses can significantly streamline and expedite the dispute resolution process and can better protect themselves from the unpredictability of litigation.
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Publication:Inside Counsel Breaking News
Date:Apr 21, 2016
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