Does your arbitration clause protect you?

Arbitration is often assumed to be a better alternative than litigation to resolve contractual disputes. In some cases this is true, but not always. Arbitration is often more expensive than litigation, and the outcome is equally unpredictable. In addition, standard arbitration provisions used in contracts do not provide the parties with the power to control the process. To have a fair shot at a satisfactory arbitration experience, you should understand standard provisions—and some smart ways to modify them.

A standard arbitration provision recommended by the American Arbitration Association (AAA) and frequently incorporated into all types of contracts reads:

Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association in accordance with its Commercial [or other] Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.

Following are some example issues, pitfalls and solutions illustrating modifications to the standard arbitration clauses:

  • Will the agreement to arbitrate be signed by, and therefore enforceable against, all potential parties to a contract dispute (e.g., your contractor's subcontractors)? Third parties who are not signatories to the arbitration agreement cannot be required to arbitrate. If you cannot get all essential parties to agree to arbitrate, do not mandate arbitration.
  • Do you have multiple contracts with the same party, each with a separate arbitration provision? Generally, an arbitrator's authority is strictly limited to that specified by the parties in the contract. An arbitrator will not have the authority to consolidate related disputes unless expressly provided in each contract. The standard arbitration provision can be revised to require the submission of all claims.
  • If you are in Ohio, the other party is in California, the arbitrator is in New York and the alleged breach of contract occurred in China, where do you want to arbitrate a dispute? Under AAA rules the arbitrator decides venue, absent an agreement by the parties. Arbitrating far from home is never easy or cheap, so it is always best to resolve the venue issue during contract negotiations.
  • Same scenario as above. Which state's or country's laws will apply to the contract dispute? You may have a valid statute of limitations defense to the claims under Ohio law, but not under California law. To avoid unpleasant surprises, the choice of law should be specifically designated in the arbitration clause.
  • If your business has an employment agreement with a key employee who has access to company trade secrets, customer lists and confidential information, can you obtain an effective temporary restraining order (TRO) and/or a preliminary injunction under the terms of the arbitration provision? AAA rules provide that the arbitrator has the authority to issue equitable remedies, but obtaining such a remedy first requires the initiation of arbitration, the selection of an arbitrator and the scheduling of a hearing—all of which take time. To preserve the immediate right to a TRO or an injunction, the standard provision should be modified to allow you to seek immediate injunctive relief through a court of law.
  • Is there a potential for a claim of theft, breach of fiduciary duties, breach of trust or intentional misconduct arising from the contract that may give rise to an award of punitive damages? Under AAA rules, the arbitrator is empowered to fashion any remedy he/she feels appropriate, even including an award of punitive damages. If a party wants to permit or preclude the arbitrator from awarding punitive damages, the standard arbitration provision should so state.

In order to ensure that your arbitration clause achieves the objectives of arbitration, i.e., speed, efficiency, fairness and cost-effectiveness, pay close attention to its terms, and consult with experienced counsel during negotiations. It is recommended that arbitration clauses used in significant contracts be reviewed and negotiated by legal counsel familiar with your business, the contract and the arbitration process.

—Richard G. Witkowski