What Every Business Should Know About Arbitration Provisions

Is arbitration really faster, cheaper, and more efficient?

Arbitration provisions are often regarded as “boilerplate:” copied from forms and templates and pasted into commercial, consumer and employment contracts with little thought. Without proper customizing and updating for 2022, these simple provisions can hold unpleasant surprises and create mischief.

Arbitration offers a number of advantages, including greater confidentiality (proceedings are not public, although nothing prevents the parties from sharing details), simplified discovery, and streamlined hearings. The flexibility to design a dispute resolution process, from the number of arbitrators to the specific types and amount of discovery that will be allowed to the location of the hearing, is a significant advantage.

During the pandemic, arbitral forums moved quickly to leverage that flexibility to hold hearings remotely, adopting detailed rules to address the pitfalls that could arise during remote proceedings and creating their own platforms to deal with documents. While the courts were limited in holding trials for months, if not years, arbitral forums continued to function, almost without interruption.

Arbitration is not perfect, however. On the downside, there can be heightened inconsistency among the vast array of arbitrators, less predictability of results without the precedential impact of favorable decisions, and limited review of adverse awards. The streamlined processes may not include an opportunity to dismiss unmeritorious cases or claims before discovery; and limited discovery can hinder the ability to obtain and use evidence from non-parties and former employees.

Arbitrators’ fees, usually charged at several hundred dollars per hour, can quickly climb into the tens of thousands of dollars. While filing fees are initially paid by the filing party and then reallocated by the arbitrators in an award, all parties must pay their share of the arbitrators’ fees before the arbitrators will proceed with a hearing. One delinquent party can hold up the hearing and create havoc.

A poorly drafted arbitration agreement can lead to unnecessary expense to litigate preliminary issues. Many agreements provide that senior executives from the parties will first informally try to resolve their disagreement before filing a claim, yet what happens when one party disputes whether that threshold has occurred? Who decides? If the contract language does not address these issues, the parties could find themselves fighting in court before the arbitration even gets out of the starting gate.

Parties also frequently find themselves in disputes over whether a particular issue arises out of, or relates to, the agreement and must be arbitrated. The most common form of arbitration provision is the generic arbitration provision that requires the parties to arbitrate “all disputes arising out of or related to” the agreement.

Generally, an issue arises out of or relates to the agreement if it has a “substantial connection” to the agreement or otherwise requires reference to or interpretation of the agreement to resolve. But this leaves a lot of muddiness around the issue of scope. For example, is a defamation claim arbitrable if it relates to comments about work done under the contract? What about a discrimination claim in the assignment of work under the agreement? A claim based on a letter of intent that preceded the final agreement? A claim by a vendor who provided services related to the prime agreement?

A corollary issue that has created substantial litigation is whether the court or arbitrator decides the issue of scope. The Federal Arbitration Act and certain state laws provide that the court shall summarily determine the issue — unless the parties clearly and unmistakably agree otherwise. A clause that expressly states that questions of arbitrability are to be resolved by the arbitrator raises no issue; but that type of precision and clarity is rarely found in a form arbitration provision.

In addition, parties can unwittingly waive a judicial forum when they incorporate the arbitration rules of numerous arbitration service providers, including the American Arbitration Association. Not surprisingly, those rules provide that the arbitrator shall have the power to determine their jurisdiction.

The overwhelming majority of courts that have addressed the issue have concluded that incorporating the AAA Rules into an agreement to arbitrate, as many template clauses do, is sufficient to evince a clear and unmistakable intent to assign questions of arbitrability to the arbitrator. The properly tailored arbitration provision will address issues about what claims are arbitrable and who decides, minimizing the risk of expensive and delaying preliminary skirmishing.

Many businesses have used arbitration agreements to limit the use of class actions, particularly by employees and consumers. The United State Supreme Court has held that parties cannot be subject to class arbitrations unless there is an affirmative “contractual basis for concluding that the party agreed to do so.” Neither contractual silence nor contractual ambiguity will support a conclusion under federal law that parties intended to consent to class arbitration.

Savvy plaintiffs’ lawyers have responded by flooding arbitration forums with masses of individual claims, numbering from a few hundred against Wild Wings to tens of thousands against Uber. Recent surveys indicate that the potential expense and distraction of managing a huge volume of arbitrations has caused some employers to rethink the use of arbitration in employee agreements.

Arbitration awards are not subject to the delay and expense of merits review in the courts. Under the FAA (and the law of most states), courts must confirm an award unless procured by fraud or corruption, or where the arbitrator was guilty of misconduct, misbehavior or evident partiality or exceeded his authority. Contract provisions that purport to expand the review jurisdiction of the courts are not enforceable. However, the major arbitral institutions now afford an opportunity for an appellate procedure, if the parties’ agreement provides.

The processes and standards of review vary among the forums, with some allowing reversal for a “material and prejudicial error of law” or “clearly erroneous” factual findings, and others merely allow the same scope of review available in the courts. Businesses should review their agreements, consider these new options and make the decision that best fits their own circumstances.

No discussion of arbitration would be complete without noting the trend to limit the use of arbitration in the employment contexts. In 2022, the FAIR Act became law, invalidating pre-dispute mandatory arbitration agreements and class action waivers covering sexual harassment and sexual assault claims. New York law purports to go farther and makes it unlawful to include a mandatory arbitration agreement covering claims of discrimination within any contract, and provides that existing agreements are null and void. While the courts have split on whether the FAA displaces the New York law, some employers have chosen to move away from binding arbitration of employment disputes.

Is arbitration faster, cheaper, and more efficient? Not for every business. And it is less likely to be so if a generic form provision is included in contracts without advice from a lawyer experienced in arbitration.

Carolyn Nussbaum is a Rochester-based partner in law firm Nixon Peabody’s Complex Disputes practice. She co-authored this article with Michael Summerhill, a Complex Disputes partner in the firm’s Chicago office.