Arbitration Agreements Are Generally Legally Binding
An overview of common clauses that make Arbitration Agreements legally binding is provided below. Section 2 of the FAA, codified at 9 U.S.C. § 2, provides that arbitration agreements "shall be valid, irrevocable, and enforceable." A valid arbitration agreement must be in writing and signed by the parties. The FAA mandates that if an enforceable agreement to arbitrate exists, courts may not refuse to compel arbitration on the basis that the controversy is not contemplated by the agreement. The FAA requires arbitration of any controversy that is within the scope of a valid arbitration agreement. However , the FAA does not authorize courts to compel arbitration of claims that are beyond the scope of the agreement. Courts are to proceed only as to those disputes – if any – that the parties have agreed to submit to arbitration. Federal courts must look to state law to determine whether the parties have agreed to submit a particular dispute to arbitration. Section 2 of the FAA declares that "arbitrary grounds that exist at law or equity for the revocation of any contract shall remain valid to the same extent as in any other contract, except that such agreement shall be irrevocable." An arbitration agreement may be revoked on grounds such as fraud, mistake, lack of consideration, illegality, unconscionability or duress (at least in California). If an arbitration agreement is unconscionable, the entire agreement may be unenforceable, or only the unconscionable provisions may be severed from the agreement. Whether an arbitration agreement is unconscionable depends on California state law.
Essential Components of an Enforceable Arbitration Agreement
A party seeking to enforce an arbitration agreement must demonstrate that the parties mutually agreed to arbitrate a dispute. Consent of the parties may be inferred from either their conduct or the contractual language. The crucial question is whether the parties intended the use of arbitration as the final means of resolving any disputes between them. However, consent is not absolute. The parties must have the legal capacity to consent to arbitration. A contract such as an arbitration agreement is not enforceable against an incompetent person. Where unexpected circumstances may have caused an incompetent person to lose the capacity to consent, a court may set aside a prior agreement.
Once a party’s consent to arbitrate is established, the courts will generally enforce the agreement. In most cases, the court will decline to intervene in what is at heart a matter of contract law. The court will defer to the agreement between the parties when examining the terms of an agreement and the relative rights of the parties.
The court will refuse to grant an injunction preventing submission of the matter to arbitration or to set aside a prior arbitration award if the parties have presented a valid arbitration agreement to the court. The court will not look to the merits of the dispute, only the agreement itself. (But see sections on express conditions on arbitration enforceability and statutory bar to enforcement.) Generally, though, once the party seeking arbitration has established the existence of an agreement to arbitrate, the burden shifts to the resisting party to show grounds for refusing to enforce the agreement. The party seeking to avoid arbitration must show that the underlying agreement is invalid under general contract principles.
Common Disputes Regarding Enforceability
In most cases, the enforceability of an arbitration provision or agreement is not at issue. However, where there has been a challenge to the validity of an arbitration provision or agreement, courts have identified a number of defenses to enforcement, including, but not limited to unconscionability and lack of notice. Arbitration provisions and agreements are often by their very nature adhesive contracts, since the parties are very rarely on equal bargaining footing. Courts have identified unconscionability as being "essentially a question of fundamental fairness in the formation of the agreement . . . . Unconscionable contracts may generally be divided into two types: procedural and substantive." Procedural unconscionability addresses the process by which an agreement is formed, and whether the resulting substance of that agreement takes a great unfair advantage of one party’s vulnerability. Substantive unconscionability looks instead at the actual substance of the contract terms which are alleged to be unconscionable, and evaluates whether they are so one-sided as to be oppressive. Both elements of unconscionability must be present in order for a contract to be found unconscionable, although the relative importance of each element will depend on the circumstances. Plaintiffs may also argue lack of notice as a defense to the enforceability of an arbitration provision or agreement. Whether or not a party’s assent to an arbitration provision or agreement has been made knowingly is determined by an objective standard which asks what a reasonably offeree would have understood from the exchange. In assessing whether the offeree objectively received adequate notice of the agreement, courts factor in whether the contract was entered into with "reasonable haste" as well as the relative sophistication of the parties. For instance, [courts] examined whether the contract terms were "consistent with parties’ general experience." The court held that it was "obvious" that the arbitration clause was included as part of the general terms of the contract, but observed that "even assuming that reasonable diligence on [plaintiff’s] part would not have uncovered . . . the arbitration clause," such lack of diligence could not serve as a basis to excuse other-wise valid contract terms. Courts have also found that arbitration terms or provisions are unenforceable where the arbitration clause comes as a surprise to the offeree or where the arbitration clause is buried within a stack of other pages that do not relate to the arbitration clause but may "trick" a reader into believing the documents do not sufficiently address the arbitration clause. Courts will also consider whether the contract is inconspicuous, or if it tends to draw special attention to itself. In this regard, online contracts for services such as those on websites of entities like Amazon.com raise similar challenges for companies who seek to enforce the arbitration provisions contained within such online agreements.
Enforcement of Arbitration Agreements is Usually Done by Courts
The role of the courts in enforcing arbitration agreements is itself often the subject of dispute. The fundamental principle is that in the absence of signed arbitration agreements the courts have the jurisdiction to determine their validity. However, most agree that this role is a limited one, usually circumscribed by the desire to encourage arbitral awards and to discourage protracted interventions by the courts.
The Federal Arbitration Act ("FAA") states that an arbitration agreement is "valid, irrevocable, and enforceable." The "FAA’s mandate to enforce arbitration agreements…is virtually automatic and particular only to the parties." Courts have stated that, if courts did not have the jurisdiction to determine whether or not an agreement exists (and to hold an agreement invalid), all would be chaos, unless the court subsequently approved of the award.
What constitutes an agreement enforceable by the court? The FAA establishes a presumption of arbitrability. Arbitrability is itself defined expansively by the FAA to be "a gateway issue", meaning that any doubts about whether the parties intended to arbitrate claims must be resolved in favor of arbitrability. Pursuant to this principle, the court will address the validity of the underlying agreement before sending the matter to arbitration, if it finds "the argument that the arbitration agreement was not formed of that it is invalid [to] go the validity of the arbitration agreement." The courts make an exception in instances when the challenge is based on a contract defence, such as fraud . The rationale is that it would be contrary to the intent of the parties to have such challenges made in the courts, where parties expressly agree to resolve any disputes arising out of their contract by way of arbitration. This is especially so where the challenge may seek to invalidate the entire contract.
To determine whether there is an arbitration agreement, the court will look to contract formation principles from state law, provided the referred-to state law contains generally applicable contract defenses. The court will not use state law grounds that are specifically designed to attack arbitration agreements to reject a party’s request for arbitration. Massachusetts law that prohibits the waiver of the right to a jury trial will be ruled out if challenged by the party, even if waiver is otherwise usually an unconscionable contract term. One federal court held that state law which allows for the voiding of unconscionable contract terms, including arbitration agreements, was preempted by the FAA.
The reasoning above can be illustrated by considering whether a waiver related to class arbitration claims is enforceable. The court in Concepcion relied on state law to find no valid agreement where the waiver related to class arbitration was ruled unconscionable. Thereafter, SCOTUS held that limiting arbitration agreements to the individual, rather than class basis does not impose unequally on parties that are not similarly situated and that the state rule was pre-empted by the FAA. The rejection of the class arbitration argument invalidated the claim of unconscionability. The result being that the courts found the waiver was enforceable, upholding the arbitration agreement.
International Agreements May Have Special Considerations
From the perspective of federal preemption, the enforceability of a contract between parties from different countries depends on whether the arbitration agreement is "international" under the terms of the New York Convention. There is no uniform definition of what constitutes an international arbitration agreement, although courts have held that if it is between two parties from different countries, that factor is sufficient to qualify the clause as an international agreement. See, e.g. Polyplastic Bags S.A. v. Futura Co. Of Am., Inc., 2001 U.S. Dist. Lexis 1297 (S.D.N.Y. 2001); Texaco Int’l Inc. v. Coparex Petroleums S.A., 2000 U.S. Dist. Lexis 6948 (S.D.N.Y. 2000); Coors Brewing Co. v. Molson Breweries, 51 F. Supp. 2d 407, 415 (D. Colo. 1999). Parties to the arbitration agreement need not be separate nationals; indeed, if a single party is a foreign national, that is sufficient to qualify the agreement as international. See, e.g., Harris Corp. v. Nat’l Iranian Radio & Telecomm. Corp., 691 F. 2d 1344, 1347 (11th Cir. 1982). The same result will occur even though the place of business for one of the parties is the same state where the lawsuit is pending. See, e.g., Leadertex, Inc. v. Morganton-Davie Cty. Chamber of Commerce, 67 F. 3d 816, 818 (4th Cir. 1995). An agreement can carry the nationality of a particular country regardless of the nationality of the parties involved. For example, a contract between an American company and an English company can still be identified as an international contract under English law. See, e.g., Polyplastic Bags, 2001 U.S. Dist. Lexis 1297. In considering the language, most courts will interpret determination of whether an arbitration agreement is international depends on whether the parties are citizens of different countries, regardless of the language used. See, e.g., Agent Orange Product Liab. Litig., 533 F. Supp. 1239, 1249 (E.D.N.Y. 1982); Boyd v. BKA Indus., 871 F. Supp. 177, 183 (N.D. Ill. 1994). Even though the arbitration agreement can be signed in a foreign country and then brought back to the state where the parties do business to be utilized in a state even if it is completely local in nature. See Gulf Coast Indus. Workers Union v. Exxon Co., 563 F. 2d 1280, 1292 (5th Cir. 1977), The citizenship of the foreign parties must be due to incorporation in foreign countries and not simply because foreign nationals work for the business. See, e.g., Japan Unity Stevedore Co. v. Consolidation Coal Co., 474 F. Supp. 1307, 1310 (S.D.N.Y. 1979). The parties have the burden of demonstrating that the dispute is international in nature due to the presence of foreign parties. See Harris Corp., 691 F. 2d at 1347; Boyer v. Northwest Airlines, 613 F. 2d 635, 640 (6th Cir. 1980). If the court finds that the agreement fails to qualify as international, it will normally dismiss the matter. See, e.g., Harris Corp., 691 F. 2d at 1348; Leadertex, 67 F. 3d at 818.
Helpful Strategies for Creating Enforceable Arbitration Provisions
When establishing the enforceability of an arbitration clause, state and federal courts both rely on well-established principles of contract law. While an arbitration clause is a contract between the parties, the Federal Arbitration Act ("FAA") provides federal courts with concurrent jurisdiction with state courts regarding actions based on arbitration agreements. 9 U.S.C. § 4. In determining the enforceability of an arbitration agreement, courts have looked to state substantive law to determine whether a valid arbitration agreement exists. In its quest for uniformity, each state requires different elements for the formation of a binding and enforceable contract. There are, however, some basic guidelines to assist in drafting an enforceable arbitration clause.
First, an enforceable arbitration clause must be contained within a written agreement. Most courts require that the writing contain sufficient content to provide assurance that the parties agreed to the terms of the clause. For instance, the arbitration clause must contain the essential elements of any enforceable contract: the names of both parties, the subject matter of the dispute, and an adequate description of the arbitration process. See, e.g., Gold v. Jefferson Credit, Corp., 70 F.3d 167 (2d Cir. 1995); Valero Mktg. & Supply Co. v. Greer Petroleum Corp., 117 F.3d 397, 399 (5th Cir. 1997); Viking, 161 F.3d at 789 (applying Mississippi law and finding that where a clause stated "the parties agree to submit their controversies to [an insurance carrier’s] Service Bureau" that this clearly evinced an intent to arbitrate the dispute). The agreement should also include an express designation of the forum in which the parties wish to hold the arbitration proceedings, providing a clear procedure for initiating, conducting and enforcing the arbitration process itself.
Second, it has been held that the failure to specifically identify which states’ laws are controlling is not fatal to finding an enforceable arbitration clause. Many arbitration clauses state that the parties agree to submit to a "binding" arbitration governed by the rules of the American Arbitration Association, or some other named arbitration association. Although there are numerous recognized organizations involved in the administration of arbitration cases, it is neither a fatal omission nor a bar to enforcement where the arbitration agreement does not explicitly identify which entity’s rules are to apply to the case and the arbitration organization’s own rules govern the arbitration process. The absence of this information, however, may be used by a party who seeks to compel arbitration to argue that the arbitration is invalid for lack of a defined arbitration process. To avoid this argument, the drafter should take care to include language such as: "Any dispute under this agreement shall be finally resolved by arbitration pursuant to the rules of [Insert Name] in [insert governing state]" or similar language.
Third , the drafter should also ensure that the arbitration clause is clear on the scope and extent of the agreement. The more general the scope of the agreement, the better. Some courts have held that an arbitration clause permitting arbitration of only "contract disputes" did not extend to tort claims that might otherwise radically expand the size of damages and risk exposure. See Prudential Sec. Inc. v. Lam, 56 F.3d 476 (8th Cir. 1995) (where parties agreed to arbitration of all disputes, including tort claims, under New York law, the argument that the arbitration agreement referred only to "contract disputes" and not tort or statutory claims was rejected). However, the drafters should note that a broad scope will not be binding if the entire agreement is deemed unenforceable under applicable state law. See, e.g., Nelson v. Insphere Ins. Sols., Inc., No. 13-20232, 2013 WL 2420595, at *5 (5th Cir. June 4, 2013) (arbitration clause that was part of a contract deemed unenforceable by a state court was also unenforceable under the FAA because of the federal court’s obligation to apply state law when determining the enforceability of the contract itself)." Tomita Techs. USA, Inc. v. Deering Co., No. 10 C 881, 2011 WL 1791385, at *10 (N.D. Ill. May 11, 2011) (court determined that an arbitration provision that was part of a sales contract voided by state law, was also unenforceable as a matter of law under the FAA).
Finally, the drafter should be careful to avoid the argument that an arbitration clause is unconscionable. In the employment context, courts have tended to allow contracts where the employer shows that they have made every effort to exclude the contract from conspicuousness and understanding. And that, overall, the arbitration agreement is fair and reasonable to both sides. See, e.g., Deo v. Shrinivas, Inc., 164 N.C. App. 560, 596 S.E.2d 263 (N.C. Ct. App. 2004). Drafters should consider the context and select a mechanism for the agreement that will best ensure a more effective and equitably applied arbitration process. For instance, by selecting a third-party arbitrator, such as the AAA or JAMS, both parties will have the option of objecting to the particular arbitrator selected. A party may minimize the potential of actual bias from a decision by selecting an AAA or JAMS arbitrator, who adheres to the selected organization’s code of ethics and can be more easily convicted for an unethical ruling. Another approach is to select an alternative dispute resolution mechanism that requires a "neutral arbitration panel of like-minded peers" to resolve the dispute. Millworkers Local 2463 v. Eastern Mass. League, 100 N.E.2d 325 (Mass. 1951) (to avert the perception of bias or partiality, a panel of three arbitrators should be selected from associations representing both parties).
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