Drafting the Arbitration Agreement

July 30, 2024

Unlike court proceedings, the arbitration process is driven by the parties’ contractual agreement. The arbitration agreement is usually included in the contract to which it relates, but parties can also enter into an agreement to refer disputes to arbitration after the dispute has already arisen, via a “submission agreement.”

The arbitration clause defines and limits the powers of the arbitrator and is enforceable unless legal or equitable grounds exist for revocation. It is highly advisable to obtain legal advice on drafting your arbitration provision early in the contract-drafting process to ensure an effective mechanism exists for enforcing the rights of the contract. To avoid ambiguity and potential disputes over interpretation, arbitration clauses should be meticulously drafted, and should account for procedural details.

Intention to Arbitrate

An arbitration agreement must clearly indicate the parties’ agreement to resolve potential disputes through arbitration rather than litigation. This agreement must be unambiguous and supported by valid consideration under contract law principles.

Scope and Powers of the Arbitrator

The arbitration clause delineates the scope of the arbitrator’s authority, which is solely derived from the parties’ agreement. The clause should specify the applicable law governing the arbitration, whether the arbitrator can grant equitable relief, and the type of damages that may be awarded. Other considerations include:

• Governing Law: Clearly stipulate which jurisdiction’s laws will apply to the resolution of a dispute. While parties are bound by applicable arbitration statutes, they have broad discretion to determine the rules that will govern the arbitration proceeding. For example, parties may reference substantive law such as “New York law,” while excluding New York procedural laws from applying.
• Cost Allocation: Specify whether the prevailing party will recover costs and fees, as this can significantly impact the economic outcomes for both parties.
• Notice and Timeliness: Establish strict requirements for initiating arbitration, emphasizing the importance of timely notification to prevent forfeiture of arbitration rights.
• Finality and Binding Nature: Emphasize that arbitration renders a final and binding decision, displacing the option to litigate in a judicial forum.

Selecting an Arbitral Institution

Broadly, arbitration can be either institutional or ad hoc. An arbitral institution is an organization with a set of its own rules regulating arbitration proceedings. Parties frequently opt for institutional arbitration in which the rules of a particular arbitral institution are incorporated in the arbitration agreement. An ad hoc arbitration proceeding is when no institution is involved.

Each reputable arbitral institution provides its model arbitration clause on its website. The American Arbitration Association (AAA) website provides standard arbitration clauses as well as clause drafting tools here. JAMS (formerly Judicial Arbitration and Mediation Services) has similar resources here. AAA and JAMS both have individualized rules and resources available by practice area and industry, including employment and commercial disputes.

The Financial Industry Regulatory Authority (FINRA), which assists in the resolution of disputes involving regulated firms and individuals in the financial services industry, has requirements for using pre-dispute arbitration agreements with customers which can be found here. It is important to note that, while FINRA can require its own members to arbitrate, even in the absence of any arbitration agreement, it also gives customers the right to request arbitration at FINRA’s arbitration forum at any time.

Model clauses contain core provisions covering fundamental aspects of an arbitration, such as scope. The applicable rules and models clauses may also differ depending on the nature of the case. For example, AAA has different rules for Commercial Arbitration and Employment Arbitration, and the rules for discovery are significantly different. While it is highly recommended to draft a clause very closely if not identically to these core provisions, the institutions also provide other optional model provisions which drafters can adopt at their discretion. By relying on an institution’s model arbitration clause, drafters can have greater confidence that the agreement will be enforceable.

Arbitrator Selection

Arbitration allows parties to drive the process of arbitrator selection, including to block the appointment of arbitrators considered unacceptable. Established arbitral institutions like AAA have their own guidelines for the arbitrator selection process which can be incorporated by reference in arbitration agreements. Typically, the institution will circulate lists of arbitrators and their resumes and recently some institutions have been adding videos prepared by the prospective arbitrator. Additional restraints on the arbitrator-selection process, such as deadlines, can provide guardrails against the ability of one or both parties to delay this part of the process.

Venue

Decide on the location for the arbitration proceeding, considering logistical factors and minimizing disruption to business operations. Consider both the law applicable to the arbitration itself as well as the law that applies to the forum in which the arbitration award is likely to be enforced.

Number of Arbitrators

Specify whether one or multiple arbitrators will adjudicate the dispute, bearing in mind that multiple arbitrators will be more costly than one arbitrator. Note that arbitral institutions may impose requirements on how many arbitrators will hear all sides of the issues, study the evidence, and decide how the matter should be resolved. For example, the Employment Arbitration Rules of both AAA and JAMS require employment arbitrations to be conducted by one arbitrator, unless the parties agree otherwise (see AAA Employment Arbitration Rules and Mediation Procedures Rule 12; JAMS Employment Arbitration Rules and Procedures Rule 7), and FINRA requires either a single arbitrator or panel of three arbitrators, depending on the amount of money in controversy (see FINRA Rule 12401).

Time and Discovery Limitations

In some cases, the parties may seek to define the time limits and submissions to conduct and complete the arbitration. For example, in a recent case, our client’s employment agreement contained an unusual provision requiring the arbitrator to render an award within 120 days after the commencement of the arbitration, with no depositions and only limited discovery (ultimately in that case, the parties agreed to extend this deadline at the suggestion of the arbitrator, but an award was nevertheless rendered within six months).

The parties may also define and clarify the scope of discovery that is desired if a dispute arises. In litigation, well-established standards may require a labor-intensive collection, management, and production of documents, but arbitration allows parties to deformalize these standards and expressly limit the scope of discovery. If a broader discovery is desired, say by a client who would want as many of their opponents’ documents as possible, then language can be included requiring parties to abide by the Federal Rules of Civil Procedure governing discovery or require the arbitrator to apply the case law of a specific jurisdiction when ruling on discovery issues. If a party has substantial information it wishes to keep confidential, then it may be preferable to significantly limit discovery by including language that restricts depositions and third-party discovery.

Conclusion

The effectiveness of arbitration clauses relies on precise drafting and consideration of all pertinent details. By customizing arbitration agreements to suit the unique needs of the parties involved, businesses can mitigate risks, expedite dispute resolution, and maintain confidentiality where necessary. Careful deliberation at the contract drafting stage can preempt future disputes, ensuring that arbitration serves as an efficient and reliable mechanism for resolving conflicts in commercial relationships.

To read how Castaybert PLLC can assist you with arbitration, click here.