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DRAFTING AN ARBITRATION CLAUSE - A CHECKLIST
By Gary H. Barnes
Downs Rachlin & Martin

Does it makes sense to use arbitration clauses in commercial agreements?

From time to time you may seek a model arbitration clause for use in a contract. There is no "perfect" model, because not everyone wants the same thing. Here is a list of things to think about when drafting an arbitration clause. By using this, you will be able to draft an arbitration clause appropriate for your client's needs in any particular contract. This is intended as a reference for legal counsel. Attorneys may find it to be a useful aid in drafting an arbitration clause. This is not intended to be exhaustive, and counsel should consider the requirements of applicable law and consult other appropriate authority before drafting arbitration clauses. Nonlawyers should obtain competent counsel.

1. Simplicity. Often parties to contracts do not want complicated arbitration clauses. Often, one sees clauses as simple as "The parties agree to submit any disputes arising from this agreement to final and binding arbitration under the _____ Rules of the American Arbitration Association." A simple one-sentence arbitration agreement is fine, if that is what the parties really want. Be aware of the different AAA rules, and select the rules most appropriate for the dispute. You may prefer to use an arbitration tribunal different than the American Arbitration Association. You may also which to counsel your client as to the remaining issues discussed in this memo, which will not be included in such a simple arbitration agreement.

2. Expenses. A well-drafted arbitration clause should provide for the division of expenses incurred in arbitration. While most expenses will be divided equally, some may be borne by one party (for example, if a party decides to have a court reporter transcribe the proceedings). Questions of equal division become more complicated if there are several parties.

3. Arbitrator Selection and Qualifications. How many arbitrators will there be? What will be their minimum qualifications? How will they be selected? Will all arbitrators be neutrals, or will each party have one or more advocate? How many neutral arbitrators will there be? A well-drafted arbitration clause will answer these questions. Some ideas: use an odd number for the number of arbitrators. If the amount in dispute is likely to be under $50,000, you will probably want to use a single arbitrator. If the amount in dispute may be in the millions, you may want several arbitrators, to protect yourself against the whim of one arbitrator, and you may wish that each party have an advocate serve as arbitrator, to assure that all important issues are understood and considered. Your agreement may provide for the number of arbitrators to vary, depending upon the amount in dispute. Qualifications should be tailored for the type of dispute. If the agreement is to be contained in a purchase and sale agreement for a business, you may want an arbitrator to be an attorney or a CPA or a business broker with a minimum of __ years experience in transactions involving the purchase and sale of businesses. Selection of arbitrators can be as simple or as complicated as you like. The easiest: reference AAA rules, and the AAA will send out lists of arbitrators, and will, upon impasse, select arbitrators. More complicated, but free of AAA administrative charges: each side selects one arbitrator, and the two arbitrators select a third. Most complicated: both parties agree to meet and confer until all arbitrators mutually acceptable are agreed upon.

4. Discovery. How much discovery will be allowed? In what form (depositions, interrogatories, requests to produce documents, requests to admit, requests for inspection or physical examination? If discovery is to be allowed, for what period of time? Here is one suggestion: After the arbitrators are selected, the parties counsel shall confer jointly with the arbitrator at the earliest convenient date to determine the discovery that shall take place. Each party shall have the right to take no more than __ depositions of potential witnesses, and each shall have the right to serve no more than __ sets of interrogatories, none of which shall include more than __ Interrogatories. Additional discovery shall be in the discretion of the arbitrator. All discovery shall be completed within __ months after the selection of the arbitrator, unless this period of time is extended by the arbitrator for good cause.

5. Scheduling. You may wish to provide for scheduling when the arbitration will occur (with reference to the completion of the selection of the arbitrator), as well as any limit on the number of days that arbitration hearings will continue (this necessarily implies limits upon the amount of time each party will have to present direct testimony, and limits on the amount of time for cross-examination). Example: Unless extended by the arbitrator for good cause shown, arbitration hearings shall begin no later than 4 months after the selection of the arbitrator ___ days shall be allotted to the arbitration hearings, and the arbitrator shall determine how much of the hearing time shall be allocated to the direct and cross examination of witnesses. The arbitrator shall allocate time equally amongst the parties.

6. Privacy. You may want to include a confidentiality provision, keeping confidential any dispute, any testimony, any documents produced, and any outcome of the arbitrator. Don't forget to include a remedy for any violation of the confidentiality provision.

7. Role of Arbitrators. You may want to consider whether the arbitrators may also serve as mediators, trying to settle the dispute through settlement negotiations, or whether the role of the arbitrator will be strictly limited to deciding the dispute.

8. Rules of Evidence. It is taken as a given in most arbitration that the Rules of Evidence do not govern, and that the arbitrator has discretion to consider whatever evidence he wants. If you want a different result, say so in your arbitration agreement.

9. Briefs. If you want to file pre-hearing or post-hearing briefs, provide for them in the arbitration agreement. You may want to require that each party prepare an opening letter brief, no more than 3 pages long, setting forth the parties position at the outset of arbitration, and allowing each party to submit briefs, with stated page limitations, to the arbitrators within __ days after the close of the arbitration hearings. You may want to vary the briefs allowed, depending upon the amount in controversy, or you may wish to allow the arbitrator to decide this matter.

10. Decision format. Do you want a decision announced orally at the close of the arbitration hearing? Or a simple written award ("The arbitrator awards $____ to the following party: _______." ). Or a full written decision? Say what you want in your arbitration agreement.

11. Appeal-Enforcement. Arbitration awards are generally thought to be final and binding. You should say this in your arbitration agreement. But you may want to consider that courts sometimes get involved, unless the arbitration agreement prevents their involvement. For example, courts may become involved if it is claimed that the subject matter is outside the scope of the parties agreement to arbitrate (this is called substantive arbitrability). Generally, courts maintain that questions of substantive arbitrability are for the courts to resolve. But the parties to an arbitration agreement could agree otherwise. In contrast, procedural arbitrability involves whether the procedures for arbitration have been properly invoked, as, for example, whether time limits for invoking arbitration have been followed. Many courts have a rule that questions of procedural arbitrability are for the arbitrators to decide. A well-drafted arbitration agreement will set forth the precise agreement of the parties on both substantive and procedural arbitrability.

Limit: The Arbitrators Authority. Most statutes allow a court to set aside an award if the arbitrator exceeds his powers. A well-drafted arbitration clause defines the powers of the arbitrator. For example, "The arbitrator shall have the authority to award compensatory damages." An award of punitive damages by an arbitrator, or an attempt by an arbitrator to issue an injunction, would undoubtedly exceed his authority under such a clause.

12. Choice of Law. Some parties want to provide that the law of a particular jurisdiction will be followed. Unless the arbitration agreement clearly indicates that the arbitrator's judgment on the law of the jurisdiction shall be final and binding, such a clause invites a losing party to go to court to set aside the award on the grounds that the arbitrator has misapplied the law. A well-drafted arbitration agreement will clearly indicate whether the arbitrator's judgment on questions of law shall be final and binding, or subject to review in court. A well-drafted clause may also identify the jurisdictions whose law is to apply to the contract. Be aware that most states have statutes which govern arbitration, and there is a federal arbitration act that may apply. These enactments may provide for grounds for judicial review of arbitration. Most statutes permit parties to agree to greater judicial review, but probably do not allow parties to agree to deny courts the very limited jurisdiction defined by statute to set aside awards procured through corruption, fraud, partiality, or upon the conduct of a grossly prejudicial hearing.

Be aware of local peculiarities. For example, the Vermont Arbitration Act contains a significant "trap door" through which parties may fall if they are not careful. It provides that an agreement to arbitrate is not enforceable, unless the parties sign a separate "Acknowledgement of Arbitration" which contains language prescribed in the statute. See 12 Vt. Stat. Ann. § 5652 (Supp. 1996). Also, the Vermont Arbitration Act may not apply, even if the parties attempt to select it. The Vermont Act states that it applies to all arbitration agreements, "to the extent not inconsistent with the laws of the United States." 12 Vt. Stat. Ann. § 5653(a) (Supp. 1996). Even if parties intend to select the Vermont Act, it may not apply if the arbitration agreement is in interstate commerce and governed instead by the federal arbitration act. Threlkeld & Co. v. Metallgesellschaft, 923 F.2d 245 (2d Cir. 1991), cert. den'd 112 U.S. 17 (1991).

13. Provisional Remedies. Unless you provide for attachment, or garnishment, or preliminary injunctive relief, you may find that your arbitration clause gives you an exclusive remedy, and you may be denied provisional remedies. Decide at the outset whether parties will be allowed to seek provisional remedies from the courts, while arbitration is pending.

14. Mediation. Do you really want arbitration? Many parties want to resolve their differences quickly and in a business-like manner. Arbitration is probably better than litigation, but, as you can see from the above, still very adversarial. You may want to consider using mediation instead (or as a preliminary). In mediation, the parties agree to negotiate any problems, using a third-party neutral to assist in the negotiations. Often, parties agree to first, directly confer if there are disputes, second, to use a mediator if they are unable to resolve disputes directly within __ days, and third, to submit lingering disputes to arbitration.