A contrarian's checklist to arbitration clauses.
This checklist can be especially helpful in advising clients who are contemplating the types of agreements that privately held businesses often want to have, whether they are business governance issues that arise from buy-sell agreements and executive employment agreements, employment litigation issues that arise from employee handbooks or personnel policies, or general commercial contracts with important vendors, suppliers, or customers.
This article examines some common assumptions and compares them with modern-day reality.
I. Arbitration Myths
A. Arbitrations Are Less Expensive
Seldom. Remember, the parties have to pay for the arbitrator, but the government pays for judges and juries. When you invoke the use of an arbitration service, you are buying into the handling fee of that service, which can equate to thousands of dollars, especially if it is pegged to the amount in controversy, as many are. Additionally, you still have to pay for the arbitrators, generally lawyers or retired judges who charge several hundred dollars per hour. (Some instead charge thousands of dollars per day.)
B. Arbitrations are Faster
Not really. The better the arbitrator, the longer it will take to get open dates. If you are using a panel of arbitrators, then you have an even longer wait for three persons to agree on open dates. In most jurisdictions, parties can resolve a case in court in less than two years, and sometimes in less than one. Arbitrations often take a year or so to resolve. In the grand scheme of things, at best, an arbitration may save only a few months.
Then, even when the arbitration clause states that it is final and binding, state laws and the Federal Arbitration Act both allow resorting to the courts, albeit on supposedly limited grounds. True, the court will not revisit the facts determined by the arbitrator, (1) but many issues can be raised in court to delay final resolution. The arbitration loser (let's assume that your side was the winner) can claim that certain issues decided by the arbitrator were not within the scope of the arbitration clause, claim that the arbitrator's decision is contrary to public policy or otherwise unconscionable, and claim that the arbitrator's decision doesn't apply on a variety of other grounds. (2 Under the Federal Arbitration Act, an award can be set aside or modified if the arbitrators "exceeded their powers"--in other words, if the arbitrators went beyond the scope of the arbitration clause--to say nothing of the rarer grounds of partiality, corruption, or fraud. (3) Indeed, the entire question of just what a court may do in reviewing an arbitration award is in disarray. As a result, the United States Supreme Court has accepted certiorari in a case raising the issue of whether the parties can agree in an arbitration clause to de novo judicial review of legal issues decided by the arbitrator or whether that violates the Federal Arbitration Act. (4)
Moreover, if there is a dispute about whether the issue is within the scope of the arbitration clause, a court, not an arbitrator, may be needed to resolve that issue. (5) An arbitrator may consider the issue of arbitrability only if the arbitration agreement contains clear and unmistakable evidence that the parties intended that the question of arbitrability be decided by the arbitrator. (6)
If a party challenges the validity of the contract as a whole, and not specifically the arbitration clause, the arbitrator decides the issue. (7) If the challenge, however, is directed solely at the arbitration agreement, the court decides the validity of the arbitration clause. (8) Even if your case involves a claim or challenge that may be resolved by the arbitrator as set forth in the above case law, ask yourself how the dispute arrived before the court that made that pronouncement, and how much cost and delay there was in reaching that point.
C. Arbitrations are Confidential
Wrong. Arbitration may be confidential for a while, and you may be able to keep people out of the arbitration hearing room who do not belong there, but the word can get out in many ways. For example, if you end up in court (see example above), the chances of getting a court to keep your case confidential are low. Furthermore, a confidentiality clause in an arbitration agreement may be unconscionable, making the entire clause fail. (9)
In federal court, parties have to convince the judge that the information is entitled to confidentiality because of a statutory or public policy. It is not enough that both parties want (or wanted at the time of the contract with the arbitration clause) some secrecy. (10) Even when the parties to the initial case agree to a protective order, the Ninth Circuit has held that the trial court abused its discretion in finding that confidentiality justified denying collateral litigants' motion to unseal filed records. (11) To be sure, the underlying case was a court case, not an arbitration, but the policies of open access to justice described by the Ninth Circuit could easily apply to the arguments you could expect in collateral litigation. (In the United States District Court for the District of Oregon, for example, most judges will not even consider a stipulated protective order that does not demonstrate, on a document-by-document basis, why each is worthy of confidentiality. Blanket protective orders are a fading memory.)
In state courts, beware of local statutory or constitutional provisions that are barriers to confidentiality. For example, the Oregon Constitution has a provision requiring that in the court system, justice remain "open and without purchase." (12)
Many other leaking opportunities are available outside the courtroom. For example, people can simply disregard a promise of confidentiality in an arbitration clause, leaving your client with the difficult task of proving damages as a result of a leak. If information supposedly vital to national security can end up on the front page of the newspaper, don't assume that you can keep the lid on something with an arbitration clause.
D. Arbitrations Avoid Expensive Discovery
While arbitrations can often avoid the expense of discovery, at the time that you are considering an arbitration clause as part of an agreement, there has been no dispute yet, so how do you know if that helps or hurts your client? Some arbitration services come with their own rules that allow practically the same discovery as in state and federal court. The most popular arbitration service (but certainly not the cheapest), namely, the American Arbitration Association, satisfies nobody seeking a clear answer because its numerous sets of rules (there are dozens, depending on the industry involved and the size of the dispute) all state that beyond producing documents, the "exchange of information" is controlled by the arbitrator(s). So your client does not even know where on the spectrum of discovery it has landed. Some arbitrators rule that the parties bargained for the quick and dirty process of showing up to tell their story at the arbitration hearing without discovery. Other arbitrators worry that their decision won't be sound without getting all the information that can be uncovered in discovery. Others yet may welcome the chance to earn more fees by expanding discovery--and the chance to rule on discovery disputes--beyond what your client ever intended.
E. Arbitrations Guarantee a Smarter Decision-Maker
This result may occur when the dispute is in a technical area and the arbitrators are specialists in that area. For example, certain types of construction, intellectual property, and union labor claims may lend themselves to a decision maker who is more "in the know," but just as there are good and bad judges, there are good and bad experts in every field. For the garden-variety commercial dispute, you are not likely to get an arbitrator with the experience in resolving disputes of a judge who does it every day.
F. Arbitrations Keep the Dispute From a Jury
First, although a perfect arbitration clause (see below) keep a case away from a jury, you must keep a few things in mind. In disputes between businesses, a jury is not going to be biased against business. Many lawyers, including some of the best defense lawyers, also believe this is true when defending a company against an individual. Juries are not as bad as some clients think.
Furthermore, sometimes a court is the best place of all to avoid a jury. Courts can make a decision to avoid a trial by granting a motion for summary judgment when the relevant facts are not disputed. I have yet to see an arbitration clause drafted into an agreement that expressly allows for a summary judgment motion to be decided by an arbitrator. Some arbitration service rules contain a rule allowing motions for summary judgment, but most do not (including the American Arbitration Association).
G. Courts Favor Arbitrations
The assumption that courts favor arbitrations means only that if there is a dispute about whether something is arbitrable, historical bias favors allowing arbitration; however, it is not that simple. While you can find opinions that say as much, beginning with the famous "Steelworkers Trilogy" decided by the United States Supreme Court, (13) on the front lines where trial lawyers operate, it seems as if courts do everything they can to decide that an arbitration clause is unenforceable. They do not favor them at all. The sad saga of Circuit City's efforts to have mandatory arbitration of employment disputes may be the best example. (14) If the arbitration clause doesn't practically imitate the exact procedure and remedies that a court would allow, it is probably "unconscionable" and unenforceable. Examples of unenforceable arbitration clauses are littered in court opinions throughout the United States: if the financial burden on the individual is too great, if there is a confidentiality requirement, if arbitration is not equally binding on all parties, if discovery rights are not equal or too slim, if a burden is imposed on a party who challenges the result of arbitration, if the period for commencing an arbitration is too short, if the remedies available--including the right to punitive damages, general damages, and attorney fees--are not exactly the same (and without limitation as to amount), if there is a waiver of the right to participate in a class action, then a court will refuse to allow arbitration to proceed or, at a minimum, sever the offending provisions. (15)
A lawyer's biggest nightmare is to learn this truth after winning the arbitration, when the loser succeeds in having it set aside by a judge. At that point your client has spent thousands of dollars on legal fees to get a result that is a nullity.
H. Arbitrations Get Everyone Involved in Solving the Dispute
It is highly unlikely that an arbitration clause will result in mandating everyone's involvement. Courts are all over the map on whether a person who has not signed a contract containing an arbitration clause can be dragged into an arbitration. (16) Time does not stop when the ink is dry on that contract. Companies merge with each other, sell or assign rights, interfere or don't interfere with other companies' contracts. As often as not, there will be dispute as to who else--in addition to the persons whose names are on the dotted line--are required to arbitrate. So here is a final chilling scenario: you have multiple claims against multiple parties. Some signed the agreement with the arbitration clause, but some did not. Some of the claims seem to fall clearly within the terms of the arbitration clause, but other claims are not so black and white. One side sues the other in court, The defendant files a motion to stop the lawsuit and require the parties to arbitrate. The judge splits the baby: some of you must arbitrate some of the claims. The rest of the issues and parties stay in court. Some parties end up in both places.
What's next? Either the arbitration or the courthouse matter will be decided first. (Indeed, the court might stay the lawsuit until the arbitration is over, but that is not a given.) Someone will win the first event. There will almost always be common factual issues in the arbitration and in the court case. The winner will begin claiming that the loser has lost the issue in the yet-to-be-determined forum--"issue preclusion" or "claim preclusion" (or what some may still call "collateral estoppel" and "res judicata"). Most courts hold that arbitration is the type of proceeding that has preclusive effect. (17)
If the client had no arbitration clause to begin with, it could have had a single trial with everyone present and avoided a lot of unnecessary legal fees. Now, which is more convenient, a contract with an arbitration clause or one without it?
II. Arbitration Solutions
A. My Client is Willing to Take the Risk of Arbitration
Okay, but please do not do what too many contracts do. Contracts either indicate that "any disputes will be resolved by arbitration" and little more, leaving it impossible to know what the rules of the arbitration are, or they say that "the parties agree to arbitrate through the services of XYZ Arbitration Service," without knowing what they have just bought into. An arbitration clause can actually be carefully drafted to remove a lot of the confusion that often results, and to increase the chances that it will be enforceable, but it takes time and effort. Using a clause from some other contract too often leads to sad surprises.
B. Arbitrations Are Not Always Bad Alternatives
While arbitrations are not always the wrong choice, my simple suggestion is to urge your clients to skip the arbitration
clause at the contract drafting stage and wait until the dispute arises. Then approach everyone involved in the lawsuit and explore arbitration at that time. If everyone agrees, you have a much better chance to manage the expense and avoid fights over the scope of the arbitration clause, the scope of discovery, who must participate, and whether the clause is unconscionable. (18)
If you're lucky, these previous discussions about how to agree on the arbitration might even slide into discussions that settle the underlying dispute.
(1) Major League Baseball Players Ass'n v. Garvey, 532 U.S. 504, 509 (2001).
(2) Banco de Seguros del Estado v. Mut. Marine Office, Inc., 344 F.3d 255, 262 (2d Cir. 2003) (scope of arbitrator's authority); Kergosien v. Ocean Energy, Inc., 390 F.3d 346, 353 (5th Cir. 2004) (manifest disregard of the law and contrary to public policy); Dawahare v. Spencer, 210 F.3d 666, 669 (6th Cir. 2000) (manifest disregard of the law).
(3) 9 U.S.C. [section][section] 9, 10.
(4) Hall Street Associates, LLC v. Mattel, Inc., 196 Fed.Appx. 476, 2006 WL 2193411 (9th Cir. 2006), cert granted--S.Ct. --, 2007 WL 142533 (Mem) May 29, 2007. The United States District Court complaint in this case was filed in March, 2000. Thus, it could be a decade before the arbitration issues are resolved. In the meantime, the First, Third, Fourth, Fifth, and Sixth Circuits allow expanded judicial review to be imposed in an arbitration clause. The Ninth and Tenth do not, and the Second, Seventh, and Eighth have discussed, but not decided the issue. See Hall Street Associates, LLC v. Mattel, Inc. petition for certiorari.
(5) AT&T Techs., Inc. v. Communications Workers of America, 475 U.S. 643, 649 (1986); Alliance Bernstein Inv. Research & Mgmt., Inc. v. Schaffran, 445 F.3d 121, 125 (2d Cir. 2006) ("Under the FAA, as interpreted by the Supreme Court, the general presumption is that the issue of arbitrability should be resolved by the courts.").
(6) Contec Corp. v. Remote Solution Co., 398 F.3d 205, 208 (2d Cir. 2005); United Bhd. of Carpenters & Joiners of America, Local No. 1780 v. Desert Palace, Inc., 94 F.3d 1308, 1310 (9th Cir. 1996).
(7) Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440 (2006) (reaffirming the holding of Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967)).
(8) Buckeye Check Cashing, 126 S. Ct. at 1208.
(9) Davis v. O'Melveny & Myers, -F.3d-, 2007 WL 1394530 (May 14, 2007). This opinion found fault with other provisions too, including but not limited to a too-short statute of limitations, and a unilateral right for O'Melveny & Myers to seek a court injunction to obtain "other equitable relief" in addition to an injunction to preserve privileged information.
(10) See Foltz v. State Farm Mut. Auto. Ins. Co., 331 F.3d 1122 (9th Cir. 2003).
(12) OR. CONST. ART. I, [section] 10.
(13) United Steelworkers of Am. v. Am. Mfg. Co., 363 U.S. 564 (1960); United Steelworkers of Am. v. Warrior & Gulf Navigation Co., 363 U.S. 574 (1960); and United Steelworkers of Am. v. Enterprise Wheel & Car Corp., 363 U.S. 593 (1960).
(14) Circuit City has been involved in litigation over its efforts to enforce arbitration clauses against its employees for years. Circuit City Stores, Inc. v. Adams, 532 U.S. 105 (2001) is the case that reached the U.S. Supreme Court. There, the court allowed arbitration, holding that the Federal Arbitration Act applied and permitted it. Since then, however, the courts have frequently blocked efforts to force arbitration by Circuit City. See, e.g., Circuit City Stores, Inc. v. Adams, 279 F.3d 889 (9th Cir. 2002). There, on remand from the Supreme Court, the Ninth Circuit found the arbitration clause unconscionable under state law because it limited damages and remedies and only bound the employee to arbitration. In Circuit City Stores, Inc. v. Mantor, 335 F.3d 1101 (9th Cir. 2003) the court found that (1) Circuit City's arbitration clause was procedurally unconscionable; (2) provisions concerning statute of limitations, class actions, cost-splitting, and employer's unilateral power to modify or terminate agreement were substantively unconscionable; (3) the arbitration filing fee provision was substantively unconscionable despite a waiver provision; and (4) the arbitration agreement was unenforceable in its entirety. In Ingle v. Circuit City Stores, Inc., 328 F.3d 1165 (9th Cir. 2003) the court found that (1) the arbitration agreement was procedurally unconscionable; (2) provisions limiting the agreement's coverage to claims brought by employees were substantively unconscionable; (3) provisions imposing a one-year statute of limitations on arbitrating claims were substantively unconscionable; (4) provisions prohibiting consolidation of employee claims were substantively unconscionable; (5) the "filing fee" provision was substantively unconscionable; (6) the cost-splitting provision was substantively unconscionable; (7) the remedies provision was substantively unconscionable; (8) provisions allowing the employer to modify the agreement unilaterally were substantively unconscionable; and (9) the unconscionable provisions were not severable. Siordia v. Circuit City Stores, Inc., No. 03-56459, 2005 WL 1368083 (9th Cir. June 9, 2005) and Al-Safin v. Circuit City Stores, Inc., 394 F.3d 1254 (9th Cir. 2005); See also McLemore v. Circuit City Stores, Inc., No. A106373, 2005 WL 1634981 (Cal. Ct. App. July 13, 2005).
(15) Vasquez-Lopez v. Beneficial Or., Inc., 210 Or. App. 553 (Jan. 31, 2007) (oppressive circumstances of formation, ban on class actions, and cost-sharing provisions rendered arbitration agreement unconscionable); Ingle, 328 F.3d at 1178 (cost-splitting, one-year statute of limitations, and limitation of available statutory remedies, provisions all unconscionable); Arnold v. United Cos. Lending Corp., 511 S.E.2d 854, 862 (W. Va. 1998) (unilateral preservation of lender's right to judicial form); Saika v. Gold, 56 Cal. Rptr. 2d 922 (Ct. App. 1996) (one-sided trial de novo provision); Walker v. Ryan's Family Steak Houses, Inc., 400 F.3d 370, 387 (6th Cir. 2005) (limited discovery); Alterra Healthcare Corp. v. Bryant, 937 So. 2d 263, 266 (Fla. Dist. Ct. App. 2006) (elimination of punitive damages and cap of non-economic damages); Adler v. Fred Lind Manor, 103 P.3d 773 (Wash. 2004) (180-day limitations provision in employment arbitration agreement); Ex parte Thicklin, 824 So. 2d 723 (Ala. 2002) (exclusion of punitive damages), overruled on other grounds by Patriot Mfg., Inc. v. Jackson, 929 So. 2d 997 (Ala. 2005); Prieto v. Healthcare & Ret. Corp. of Am., 919 So. 2d 531, 533 (Fla. Dist. Ct. App. 2005) (deprivation of statutory remedies, limitation of non-economic damages, exclusion of punitive damages, and attorney fees).
(16) Wash. Mut. Fin. Group, LLC v. Bailey, 364 F.3d 260, 267 (5th Cir. 2004) (nonsignatory plaintiff bound by arbitration provision contained in contract suing under); Blinco v. Green Tree Servicing LLC, 400 F.3d 1308, 1312 (11th Cir. 2005) (compelling non-signatory plaintiff to arbitration under equitable estoppel theory); In re Kellogg Brown & Root, Inc., 166 S.W.3d 732, 741 (Tex. 2005); ("[A]lthough a non-signatory's claim may relate to a contract containing an arbitration provision, that relationship does not, in itself, bind the non-signatory to the arbitration provision. Instead, a non-signatory should be compelled to arbitrate a claim only if it seeks, through the claim, to derive a direct benefit from the contract containing the arbitration provision.") (emphasis added); Bel-Ray Co. v. Chemrite (Pty) Ltd., 181 F.3d 435 (3d Cir. 1999) (no basis for the plaintiff signatory to compel nonsignatories to arbitrate).
(17) Boguslavsky v. Kaplan, 159 F.3d 715, 720 (2d Cir 1998); King v. Burlington & Santa Fe Ry. Co., 445 F. Supp. 2d 964, 976 (N.D. III 2006).
(18) When the American Bar Association Task Force on ADR Effectiveness surveyed practitioners in its Litigation Section, it found that only fifty six percent of respondents believed arbitration was more cost effective than the courtroom. Sixty percent of those polled reported that they suggest arbitration to their clients less than three times out of ten, and thirty-four percent reported that they advise against arbitration six times out of ten. See Survey on Arbitration, ABA Section of Litigation Task Force on ADR Effectiveness (American Bar Association 2003). This article hopefully provides justification for such a report card.
Bruce Rubin is a partner in the Portland, Oregon office of Miller Nash, LLP, where he heads its Business Governance Litigation Team. The firm also has offices in Seattle, Vancouver (Washington), and Central Oregon. Mr. Rubin was on the IADC Trial Academy Faculty in 2006. In addition to business governance disputes, he has tried a variety of complex commercial and employment cases and belongs to the Oregon, Idaho, and Washington state bars.
Jennifer J. Roof an associate in the Miller Nash litigation department, joined the firm in 2001. Jennifer focuses her practice primarily on employment litigation, ERISA, commercial litigation, and creditors' rights. She previously served as a judicial clerk at the Tenth Circuit Court of Appeals for the Honorable Bobby R. Baldock.
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|Author:||Rubin, Bruce A.; Roof, Jennifer J.|
|Publication:||Defense Counsel Journal|
|Date:||Jul 1, 2007|
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