Why Arbitration Clauses Should Be Customized

WHY ARBITRATION CLAUSES SHOULD BE CUSTOMIZED

By Marvin O. Youngfn1

There are a number of reasons why a customized arbitration clause should be drafted and used rather than a standard short form clause if arbitration is to be utilized to resolve disputes under the agreement.

A recent case from the Missouri Court of Appeals, Western District, Getz Recycling, Inc. v. Loren L. Wattsfn2 suggests two very good reasons for using a customized arbitration clause in a lease, contract or other written document providing for arbitration in the event of a dispute rather than utilizing a standard short form clause, such as the one suggested by the American Arbitration Association. The Getz Recycling case involved a dispute over whether a Lessor of a rock crushing machine could enforce an arbitration clause against a Lessee of equipment under a rental agreement which contained the following arbitration clause:

The first question addressed by the court was whether the arbitration clause was broad enough to encompass the claims and counterclaims made in the case. As can be seen from reading the arbitration clause, it is limited to disputes as to the "terms and/or conditions set forth in the agreement." The Lessee argued that his claims for breach of contract, breach of implied warranty, breach of express warranty, breach of warranty of merchantability, negligent misrepresentation and misrepresentation are not within the scope of the arbitration clause because they do not relate to any term and/or condition of the agreement. The court found that the claims and counterclaims are within the scope of the arbitration clause because the contract included a typical disclaimer of warranties, but this seemed to be a close question.

The second question considered by the court was whether Getz had waived its right to arbitrate because it sought judicial relief in the form of a request for an injunction and a writ of replevin before invoking the arbitration clause. On this point the Court held that by this trial-oriented activity Getz had effectively waived its right to arbitrate, and the Court refused to enforce the arbitration clause for this reason.

If the arbitration clause had provided that all disputes arising under the agreement are subject to arbitration rather than disputes over "the terms and/or conditions as set forth in the agreement," the first question could have been avoided. The second question could have been avoided by providing in the arbitration clause that remedies seeking to preserve the status quo prior to the invocation of arbitration under the agreement would not waive the arbitration clause. Some arbitration clauses even provide a mechanism for an arbitrator to grant such interim relief by allowing the appointment of a provisional arbitrator.

The author believes there are at least thirteen reasons (including the two mentioned above) for utilizing a customized arbitration clause rather than relying on a short form clause. These reasons are as follows:

1. The most important aspect of any arbitration is the selection of a good arbitrator or arbitrators. Since obtaining a good arbitrator is of critical importance, the arbitration agreement should specify the qualifications of persons to be eligible for selection as arbitrators. In every case, the person selected as an arbitrator should have a judicial temperament, should have a reputation for fairness, should be free from any bias concerning the subject matter and should have training as an arbitrator. The author happens to believe that in most cases arbitrators should be mature attorneys who have experience in deciding disputes in an impartial manner and perhaps who have some familiarity with resolving business disputes of the type in question.
2. The arbitration clause should specify the types of disputes which are subject to arbitration. In some cases the parties may wish to exclude certain types of disputes from the arbitration clause, such as breach of contract or tort claims. If disputes of any type arising under the agreement are intended to be subject to arbitration, then the arbitration clause should say that. If the dispute clause involves only a disputed monetary amount, the parties may want to consider the use of baseball type of arbitration in which each party makes a final and best offer and the arbitrators are limited to selecting the final and best offer of one party for the award to be entered. This tends to cause both parties to be reasonable and realistic in their demands. It also eliminates any tendency to split the difference by an arbitrator.
3. The arbitration agreement should specify the number of arbitrators which will be selected. If the dispute is below a certain monetary threshold, (perhaps $500,000) a single arbitrator may be sufficient. In larger cases the author believes that the case should be decided by three neutral arbitrators. If one of the arbitrators selected should go off the deep end, there is the good possibility that the other two arbitrators will still render a sound award. Selecting two non-neutral party-appointed arbitrators adds very little because in that event the case is still being heard by a single neutral arbitrator.
4. Another important provision to include in a customized arbitration clause is a procedure to select arbitrators. The agreement should provide a failsafe method of selecting arbitrators that avoids appointment by a judge who may or may not appoint someone with proper qualifications. Counsel also will want to investigate the reputation and any possible biases of persons proposed as arbitrators. Proposed arbitrators should submit a list of references of attorneys who have tried cases before such arbitrators are who have personal knowledge of the qualifications and fairness of the person proposed as an arbitrator. The agreement should provide that counsel for each party shall have the right to use all available resources to learn as much as possible about proposed arbitrators, including joint interviews with prospective arbitrators which in many cases can be conducted by telephone.
5. Other important provisions to be included in a customized arbitration clause are specific provisions on permitted discovery. It is customary to require an exchange of documents and to outlaw the use of interrogatories. However, the subject of discovery depositions is an open one. Most arbitration rules are silent on the discovery depositions. Some arbitration agreements flatly prohibit the use of depositions for discovery; other arbitration agreements allow a limited number of discovery depositions. The author believes the arbitrator should have some control over the number and scope of depositions permitted depending upon the subject matter of the arbitration and the agreement of counsel regarding depositions. If this is to be the case, it is important that the arbitration clause so provide. A recent Missouri case, CPI/Kupper Parker Communications, Inc. v. Hartfn3 involved a dispute in an arbitration regarding the number of depositions a party could take. The court held that if there is a valid agreement to arbitrate, the arbitrator must interpret the arbitration clause and make decisions about the parameters of discovery. If depositions are permitted, they should be included in the scheduling order entered by the arbitrator following the preliminary hearing. Expert witnesses should be permitted in arbitrations involving technical issues, and discovery directed toward expert witnesses may be desirable. If good arbitrators are selected, the matter of depositions can be left largely to the discretion of the arbitrators.
6. The arbitration agreement should include provisions relating to interim relief such as injunctions and replevin suits which are used to preserve the status quo or to prevent the disappearance of important items. The arbitration agreement should, at a minimum, provide that use of such interim remedies by resort to a Court does not waive the right of arbitration. Many arbitration agreements give arbitrators the power to grant interim relief, but in order for this to be effective there must be a mechanism to obtain an expedited appointment of an arbitrator for that purpose in order to preserve the status quo.
7. The arbitration agreement should specify the applicable procedural and substantive law to be applied by the arbitrators. If the dispute involves interstate commerce, the arbitration agreement will be subject to the Federal Arbitration Actfn4 regardless what the agreement says, and will pre-empt any state law.fn5 The provisions of the Federal Arbitration Act have been construed very broadly in determining whether interstate commerce is present.fn6 If interstate commerce is not involved, the arbitration law of a particular state will undoubtedly apply, and the arbitration clause should specify which state law applies. At least 35 states including Missouri have adopted the Uniform Arbitration Act.fn7
8. The arbitration agreement should also specify what forms of relief the arbitrators are authorized to award. This normally includes compensatory damages, declaratory relief, specific performance, injunctive relief, and forms of relief authorized by applicable statute (which could include treble damages). If the agreement to arbitrate involves application of a statute which permits punitive damages, the arbitration clause should not prohibit punitive damages. A prohibition on punitive damages could invalidate the arbitration agreement in such case.fn8
9. The arbitration agreement should include time limits of various types to prevent delay by one party and should provide that these time limits may be extended by agreement of the parties with the concurrence of the arbitrators.
10. The arbitration agreement should indicate whether the parties desire a reasoned award or whether it is sufficient for the arbitrator to simply enter an award which states ultimate conclusions. The author believes that a reasoned award should be required because it forces the arbitrator to be more careful about the decision he or she is making and because it gives the losing party some understanding of why he or she lost the case. It is very frustrating to be on the losing side of a case and not be able to obtain any information as to why the decision was rendered in favor of the other party.
11. The arbitration agreement should specify the venue of the hearing. The location of the hearing sometimes becomes contentious when one party is in one city and the other party is in the other city. This can be avoided by specifying the geographic location of the hearing in the agreement.
12. A customized arbitration clause may include a provision for good faith negotiations by specified senior executives of a company for a specified period of time before the arbitration clause can be invoked by either party. The arbitration clause may include a provision that mediation of the dispute is a condition precedent to invoking arbitration. If this is the case, a detailed mediation clause should be included. If these provisions are utilized they should include specific time limits.
13. While various arbitration rules and enabling statutes grant extensive powers to arbitrators, it is a good idea to spell out specifically the powers of the arbitrators. Arbitration is a contractual remedy and arbitrators have only the powers conferred on them by the arbitration agreement. It is important that such powers (or any limits on such powers) be delineated in the arbitration agreement. As stated by the court in Westridge Investment Group, L.P. v. McAtte, "The powers of the arbitrator are set and defined by the contract to arbitrate."fn9

Important note concerning the Missouri Arbitration Act. If a contract contains an arbitration clause which is governed by the Missouri Arbitration Act, it is important that the notice required by Section 435.460 be included. Section 435.460 provides as follows:

If the contract involves interstate commerce and is governed by the Federal Arbitration Act, that requirement can be ignored.fn10