Reproduced with permission
from BNA's Corporate Counsel Weekly, Vol. 14, No. 17, pp. 8 et. seq. (April 28,
1999). Copyright 1999 by The Bureau of National Affairs, Inc. (800-372-1033)
GENERIC ARBITRATION CLAUSES ARE BAD MEDICINE
by Jeffrey W.
Contract drafters too often take the easy way out
when it comes to arbitration provisions. Rather than craft a clause that makes
sense in the context of the particular transaction at hand, they simply plunk
down some generic boilerplate: †"Any and all disputes arising out of or related
to this agreement or the breach thereof shall be arbitrated . . ."
Thatís fine if youíre sure you really want to
arbitrate anything and everything, donít care that discovery may be unavailable,
and have no interest in limiting the risk of runaway damages. Of course, most
companies do have preferences when it comes to arbitration, but these are
generally far from the top of the priority list at deal time. Only when a
dispute develops does the inadequacy of the arbitration boilerplate become
The time to plan for arbitration is when you
negotiate and draft the agreement, not when the dispute breaks out. By that
time, it may be too late ó the warring parties probably wonít be able to agree
on anything, leaving resolution of vital procedural matters to the
arbitrator, who may be inclined to do things in the "usual" way. Simply
incorporating the rules of an arbitral institution does not solve this problem
because those rules rarely contain meaningful provisions with respect to such
concerns as the scope of discovery and limits on punitive damages.
The fact is that the "usual" arbitration clause is a
dangerous myth. Parties have almost absolute freedom to shape arbitration
provisions to their particular needs. Here are a few suggestions:
First, determine the type of issues you want (and
donít want) to arbitrate. Will you really want to arbitrate a defamation
claim arising out of your joint venture? Thatís the type of claim for which a
meaningful appeal (generally not available after an arbitration) may be highly
desirable. So if the resolution of particular claims will benefit from the kind
of protections that only judicial resolution provides, proscribe the arbitration
of those claims in your arbitration clause.
Second, try to foresee the nature of likely disputes
and what that means for discovery. If your company is entering a franchise
agreement as a franchisee, it likely will need information in the hands of the
franchisor in the event of a dispute. Thus, it may want an express provision
guaranteeing the right to exchange documents or take a reasonable number of
depositions, at least if the amount in dispute is sufficiently large. The
franchisor, on the other hand, may want a provision precluding depositions and
otherwise limiting discovery. The party that looks ahead will come out
Third, think about remedies. One reason companies
often prefer arbitration is their expectation that an arbitrator is less likely
than a jury to award exorbitant damages, whether compensatory or punitive.
Thatís generally true, but arbitrators have a lot of flexibility when it comes
to remedies, and a rogue award rarely can be cut back on appeal. So if you want
to preclude the award of lost profits or punitive damages, say so.
One obstacle to the limitation of punitives is that
the other side may be reluctant to agree. A more subtle means of obtaining the
same limitation is to choose the arbitration law of a state that forbids or
limits the authority of an arbitrator to award punitives. For example, Illinois
arbitration law, according to several Illinois appellate courts, precludes an
arbitrator from awarding punitives unless the parties have expressly authorized
it to do so. See Ryan v. Kontrick, 1999 WL 167522 (Ill. App. Mar. 26,
1999); Edward Elec. Co. v. Automation, Inc., 593 N.E.2d 833 (Ill. App.
1992). If you choose to go that route, make clear that the arbitration clause
itself (as opposed to the substantive contract provisions) is governed by the
preferable state law. Otherwise, federal arbitration law, which is more
deferential to arbitral punitive damage awards, may apply. See Mastrobuono v.
Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995). For example, you might
consider the following:
The arbitration law of Illinois shall govern this
contract to the fullest extent permitted by law, excluding the Federal
Arbitration Act and the arbitration law of all other states, irrespective of the
location of the arbitration proceedings or of the court in which any related
judicial proceedings may take place.
Fourth, consider what is probably the biggest failing
of arbitration, the inability to obtain effective review of an erroneous
decision. You may want to expand the scope of judicial review, for example, by
authorizing de novo review of legal determinations and "clear error"
review of factual findings. If so, be sure to require a written opinion by the
arbitrator, so that the reviewing court will have some findings to review. Some
jurisdictions, including the Fifth and Ninth federal circuits, have upheld
partiesí expansion of judicial review; others, including the Seventh and Eighth
Circuits, have indicated skepticism on the ground that the scope of judicial
review is up to Congress. Compare Lapine Tech. Corp. v. Kyocera
Corp., 130 F.3d 884 (9th Cir. 1997); Gateway Tech., Inc. v. MCI, 64
F.3d 993 (5th Cir. 1995) (parties may expand) with UHC Mgmt. Co. v. Computer
Sciences Corp., 148 F.3d 992 (8th Cir. 1998); Chicago Typographical Union
v. Chicago Sun-Times, Inc., 935 F.2d 1501 (7th Cir. 1991) (parties may not).
One way to obtain review but avoid the courts altogether is to provide for an
appellate arbitration panel in your arbitration agreement. If you do so, be sure
to specify the appellate procedures.
Finally, if you want the arbitration agreement to
bind a third party ó such as the other partyís guarantor or surety ó be sure to
say so expressly and have the third party sign the arbitration provision
separately. The guarantorís written agreement to guarantee a partyís contractual
obligations as a whole may be insufficient to bring it within the reach of the
arbitration clause. See Grundstad v. Ritt, 106 F.3d 201 (7th Cir.
These are but a few options, offered to encourage
creative thinking on the part of counsel drafting arbitration provisions. The
point is to tailor your arbitration provision to your company and the particular
transaction. The arbitration clause should not be a hasty postscript to an
agreement, but rather an essential part of transaction planning. Prudent
anticipation can avoid anguish down the road.
Jeffrey Sarles is a litigator
at Chicagoís Mayer, Brown & Platt. He also is an adjunct professor at
Northwestern University School of Law, where he teaches a seminar in commercial
[Copyright © 2000 Mayer, Brown & Platt. This
Mayer, Brown & Platt article provides information and comments on legal
issues and developments of interest to our clients and friends. The foregoing is
not a comprehensive treatment of the subject matter covered and is not intended
to provide legal advice. Readers should seek specific legal advice before taking
any action with respect to the matters discussed herein.].