Ethics in Brief: Be Careful of Arbitration Provisions

By: Mitchell L. Lathrop

Your corporate client asks for advice. He’s heard about arbitration and provisions in contracts which require the participants to resolve disputes through arbitration. After all, the client has also heard that arbitration is faster and cheaper than litigation. “Arbitration can be an effective way to resolve a dispute in less time, at less expense, and with less rancor than litigating in the courts.”[1]  Is the client correct? Perhaps, but it depends upon what the arbitration provision says. Also, the same ethical considerations regarding conflicts,[2] confidentiality,[3] diligence[4] and communication with your client[5] apply just as they would if you were representing a client in litigation.

At the outset, competence requires that the lawyer be knowledgeable regarding some of the significant differences between arbitration and judicial proceedings.[6] If the lawyer is asked to draft an arbitration provision, the requirement of competence demands that the lawyer have training in arbitration so issues like procedural and substantive unconscionability can be avoided.[7] So, too, many statutes involving military personnel present unique issues.[8]

While arbitration is often promoted as being faster and less costly than civil litigation, that is not always true. While arbitral awards are almost never reversed on appeal, there are exceptions. Arbitration proceedings are normally confidential, at least until court enforcement of an award is sought. A competent practitioner will also remind the client that arbitrators are not bound to follow the law, but can make decisions based upon purely equitable grounds, although manifest disregard of the law can result in an award being vacated.

Arbitration agreements rest on an equal footing with other contracts,[9] and courts must enforce, them according to their terms. Like other contracts, however, they may be invalidated by generally applicable contract defenses, such as fraud, duress, or unconscionability.”[10] Since the 1925 enactment of the Federal Arbitration Act (“FAA”),[11] more and more companies are including arbitration provisions in their contracts. The FAA reflects a “liberal federal policy favoring arbitration agreements, notwithstanding any state substantive or procedural policies to the contrary.”[12] “To ensure that arbitration agreements are enforced according to their terms, ‘the FAA pre-empts state laws which “require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration.’”[13] If the contract containing the arbitration provision has no nexus outside of California, the California Arbitration Act[14] will apply. Its provisions are essentially the same as its federal counterpart.[15]

Today most on-line entities providing goods or services build arbitration provisions into their subscriptions or contracts. When a dispute arises, one of the first defenses the provider is likely to raise is a demand for arbitration. Success or defeat for the party seeking arbitration will depend on what the arbitration provision says. If you are the lawyer charged with drafting an arbitration provision there are a few rules of which you must be aware.

Arbitration requires an agreement by the parties to arbitrate any differences in accordance with the arbitration clause in the particular contract. The arbitration agreement must be in writing.[16] When an arbitration agreement is challenged one of the first things a court will examine is whether the parties have agreed to arbitrate and whether their agreement covers a particular controversy.[17]

When the drafter of an arbitration provision overreaches the provision may become unconscionable. While “there is nothing inherently unfair or oppressive about arbitration clauses,”[18] and arbitration agreements are not in themselves unconscionable.[19] Instead, unconscionability is an affirmative defense, and the party asserting the defense bears the burden of proof.[20] For example, where an arbitration agreement of infinite duration required an employee to arbitrate all claims against the employer, its agents, affiliates, and employees irrespective of whether they arose from the employment relationship, the court unhesitatingly held the arbitration provision to be unconscionable.[21]

In order to be found unconscionable an arbitration provision must be both substantively and procedurally unconscionable. In Davis v. TWC Dealer Group, Inc. (Davis)[22] the court held that small, difficult-to-read print supported a finding of both substantive and procedural unconscionability; however in the later case of Fuentes v. Empire Nissan, Inc. (Fuentes)[23] the court disagreed, holding that “tiny and unreadable print” is a problem of procedural unconscionability only and should not be “double counted” as a problem of substantive unconscionability.

Recognizing the conflict between Davis and Fuentes, the California Supreme Court granted review. In Fuentes v. Empire Nissan, Inc.[24] the California high court held that “a contract’s format generally is irrelevant to the substantive unconscionability analysis, which focuses on the fairness of the contract’s terms, but that courts must closely scrutinize the terms of difficult-to-read contracts for unfairness or one-sidedness.”[25]

Caveat: Even if a party has a perfect arbitration provision in a contract, the right to arbitrate can be waived if the parties engage in conduct inconsistent with a desire to arbitrate, i.e., litigation. The waiver inquiry is exclusively focused on the waiving party’s words or conduct; neither the effect of that conduct on the party seeking to avoid enforcement of the contractual right nor that party’s subjective evaluation of the waiving party’s intent is relevant.[26]