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Arbitration Clauses: Will They Work for You? By Albert A. DeNapoli, Esq.

Tuesday, January 16, 2007 - By: Albert A. DeNapoli

Arbitration Clauses: Will They Work for You?
By Albert A. DeNapoli, Esq.

To avoid costly and many times slower proceedings in our court systems, alternative dispute resolution provisions in contracts and sometimes as independent agreements have become very popular. Unfortunately, however, as these provisions have become more popular, they have become more complicated, many times leading to situations where their implementation is neither faster than an "old fashion" court case nor ultimately less costly.

Nevertheless, when used correctly and with attention to the desired end result clearly in focus, arbitration agreements can still be an important element of any contractual relationship. To keep the goal of such agreements in focus, parties to the contract need to explore and understand the complications that can arise from these otherwise sometime seemingly benign contract provisions.

Also seemingly benign is the definition found in Section 2 of the Federal Arbitration Act, which provides written arbitration agreements "shall be valid, irrevocable and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." With this simple phrase, the drafters of the statute do everything but make the interpretation of arbitration agreements simple; opening the door instead, but understandably, for the panoply of arguments, and then some, made in contract battles over the years.   

Fundamentally, courts view arbitration agreements as a matter of contract and will not force a party to arbitrate any dispute which it has not agreed to submit to such resolution. Notwithstanding the general view of the court to only bind parties to contracts to which they, in fact, have agreed, the body of law created in the federal courts adopted by most state courts is to favor arbitration. So long as the arbitration forum provides for the "fair and adequate enforcement of a party's statutory rights," courts will generally uphold a contract's arbitration provisions.

In the first instance, courts must determine whether the contracting parties had submitted a particular dispute to arbitration. To determine this question of arbitrability, courts consider three elements: (1) its policy favoring arbitration agreements; (2) the exception to this policy based on the "presumed" intent of the parties; and (3) whether there is in the agreement a clear and unmistakable expression of actual intent that the parties want this matter to be decided by arbitration.

Often, however, determining which forum will determine the initial question of arbitrability is the first battleground between conflicting parties to an arbitration agreement. Usually, the party opposing the arbitration will argue that the court is the correct forum to decide whether the dispute set forth in the contract is or is not covered by the arbitration provisions, while the party seeking to bring the dispute to arbitration will argue that it is the arbitrator's province to make such a determination. Each believing that starting in its forum of choice will set the stage for the entire dispute resolution.

The party opposing the arbitration will often claim that its statutory rights can not be vindicated in the arbitration forum. At its simplest level, courts have said that courts will determine question's of arbitrability that raise the substantive rights of the parties, while those involving merely procedural questions, may be decided by an arbitrator. Disputes over arbitrability are, however, rarely that simple.

Even in situations where substantive rights are at issue, courts have generally held that where there is a clear conflict between remedies set forth in the language of the contract and those found in the language of the federal and/or state statute, the court will decide the question of arbitrability. On the other hand, where there is an ambiguity between the language of the contract and that of the federal and/or state statute, the arbitrator will decide. In somewhat circuitous reasoning, it is often the court which will determine whether such a legal ambiguity in the contract exists. Once the court determines a legal ambiguity, the question of arbitrability will then be decided by the arbitrator. By way of example, the legal ambiguity between the contract and the statute in some cases lies in the use of the word "may" as opposed to "shall" in the provisions which provide the remedy in question. Accordingly, it is important not only to draft the provisions of the contract with this in mind, but also to be cognizant of the applicable federal and/or state statute against which the provisions of the arbitration clause may trigger a comparison. 

Many times arbitration is desirous because one contracting party seeks to have the other party waive certain remedies by agreeing to arbitration. Again, drafters of such clauses must be aware that there are certain remedies that cannot be waived due to considerations of public policy. Furthermore, whether these remedies are available and if so waivable may differ if the analysis is done under federal or state law.

In order to protect the validity of arbitration agreements, drafters will often include a provision called a "savings clause." These clauses generally maintain that the contract sets forth the exclusive remedies of the parties, unless applicable law provides otherwise. This condition is used to "save" the arbitration component of the agreement although a particular provision may be stricken because it denies a remedy which can not be waived. Accordingly, one particular and common form of a "saving clause" is a "severance clause."   Such clauses seek to "sever" any of the contract or arbitration provisions which are in violation of the law or public policy while "saving" the remaining language. Again, while courts may use these severance clauses to "save" the arbitration language, drafters of such contract provisions must be cognizant that certain remedies they have sought to exclude from arbitration may be reinstated in order to save the arbitration. By way of example, a savings clause may allow the recovery of attorney's fees and costs, where an arbitration provision which denied such a remedy would have otherwise been stricken.

Along the same lines, drafters of arbitration agreements must also be careful that they have not inadvertently provided contract language which will have a retroactive effect and revitalize claims which would have otherwise been time barred.

While arbitration is still in many cases a reasonable alternative to "courthouse" litigation legal challenges through the years have complicated the simplicity behind the idea of a forum where the parties can agree to resolve their disputes under their own terms, more quickly, efficiently and economically.  Often arbitration agreements are drafted by transaction attorneys who, while very competent, have never seen the practical effects on litigation of the various aspects of their agreements. Involving litigation attorneys to review and assist in the drafting of the arbitration language can help to protect the desired result of the contract. Flow charts which detail the goals of the arbitration agreement can be used effectively in drafting these provisions. Keeping the end result in mind, the drafter must chart out the effect the applicable laws of the controlling jurisdictions (and possibly the rules of the chosen arbitration forum if one is so chosen) will have on the efforts to reach that goal and then craft the language to specifically address these issues. By understanding the varied complications affecting these agreements and drafting in such a manner as to reduce their ability to defeat the intent of the parties, arbitration agreements can, however, maintain their viability as an important strategic tool.

Originally published by in January 2007.