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Drafting Arbitration Clauses

Over the years I have seen dozens of contracts with dreadful arbitration clauses.

They are generally found near the end of the agreement, with the other so-called “boilerplate”. One often wonders whether the lawyers even read them before the contract was signed. Almost certainly, the business people didn’t. One consequence of this neglect is that, if and when the clause must be dusted off and used in a dispute, it may not work as intended. And unworkable arbitration clauses tend to give the process as a whole a bad name.

There are 7 essential elements of an effective arbitration clause.

  1. There must be a binding agreement to arbitrate. Avoid wording such as “the parties may submit the dispute to arbitration.” The current trend is toward dispute resolution clauses that involve some form of escalation and negotiation, or mediation, before the parties can go to arbitration. On the whole, this is a good thing. However, the clause must be clear when the parties can trigger arbitration. There have been many cases fought over whether arbitration is mandatory or not, and if so, when. (For example, A.G. Clark Holdings Ltd. v HOOPP Realty Inc., 2013 ABCA 101, where arbitration was stayed by the court because the parties had failed to take steps set out in the contract which were determined to be pre-conditions to arbitration.)
  2. The scope of arbitration must be defined. Are all disputes subject to arbitration or only specific matters? Many standard clauses automatically exclude certain matters, such as intellectual property claims, from mediation or arbitration. That may not be wise. It may mean that the parties have to fight separate but related claims in two places and run the risk of incomplete, inconsistent or contradictory results.
  3. The arbitration rules (or applicable arbitration statute) must be determined and should be expressly stated. Some assume that this is covered by the general choice of law clause in the contract. It’s not. And simply saying “…in accordance with the [Arbitration Act]…” is also usually not enough. If the parties want to use the Rules of a particular administrative body (e.g. the ADR Institute of Canada, the American Arbitration Association or the International Chamber of Commerce) that needs to be clearly stated. Careful consideration should be given to the choice of Rules. There can be significant differences in time and cost.
  4. There must be clear time limits. This applies to any pre-arbitration steps, such as negotiation or mediation, to the appointment of the arbitrator, any pre-hearing steps in the arbitration, the hearing itself and the rendering of the award. Most arbitration statutes or administrative rules give the arbitrator the power to set time limits, one he or she is appointed, but many cases get hung up before there is an appointment. And strict time limits in the arbitration clause will help keep the process moving if one of the parties is dragging their feet.
  5. State the place and language of the arbitration. The “seat” is not necessarily the same as the physical location of the hearings. The governing law of the contract will determine substantial legal issues; but the law of the seat or venue of the arbitration may determine many procedural matters, including questions about the jurisdiction and powers of the tribunal and enforcement of the award. Parties may be drawn to the idea of specifying a neutral location for arbitration, but they must be careful to choose a suitable venue.
  6. Specify the qualifications of the arbitrator(s), if that expertise is one of the reasons for choosing arbitration. But be careful not to specify qualifications that are so narrow that they cannot easily be met. It may then be impossible to get an arbitrator who meets the criteria.
  7. Determine whether there should be one arbitrator or three. One is usually quicker and cheaper, but there is often a fear that the arbitrator could make the wrong decision, especially if there is no appeal. Three is more expensive, and coordinating schedules is that much more challenging, but three heads may be better than one.

To get all of the potential benefits of arbitration – simplified procedure, speed, confidentiality, expert adjudicator – these things must be clearly set out in the arbitration clause. If they aren’t, a reluctant party has many opportunities to drag things out and frustrate the original intentions of the parties.

Other matters, which the parties may choose to include in the arbitration clause, include:

  • Expedited arbitration, with shorter time limits and simplified procedure, for certain matters. For example, this could include billing disputes under a specified dollar limit.
  • Limited rights of appeal, for example on questions of law. If confidentiality is a concern, the appeal could be to a separate panel of arbitrators.
  • Limitations on discovery, particularly electronic discovery. This is one of the factors driving up the costs of commercial arbitration. Often there is very little to be gained by either party, particularly in situations where both parties usually have access to the information they need to present their case. Sure, there may be a “smoking gun” in some internal email, which will open the door to a fraud or misrepresentation claim, but more often the only thing the parties get from extensive discovery is a big legal bill.
  • Confidentiality. Arbitration is private; it is not necessarily confidential. So if confidentiality is important (such as a dispute over trade secrets) it is generally a good idea to expressly state that both the arbitration itself and all information disclosed during the process is confidential.

For a simple, but functional, arbitration clause, look to the sample clauses published by one of the arbitration bodies. The ADR Institute of Canada model clauses are available here.

The International Centre for Dispute Resolution, which is the international division of the American Arbitration Association, has model clauses for international contracts, including wording for common variations. The American Arbitration Association also has a Clause Builder Tool for commercial and construction mediation and arbitration. Although the tool is designed for US domestic arbitration, it provides a useful checklist of additional clauses that may be used in any arbitration agreement. (The AAA website indicates that an international clause builder tool is coming soon.)

The Clause Builder also demonstrates one of the dangers inherent in the unlimited flexibility of arbitration. It is all too easy to vary the standard clause to deal with a multitude of specific issues, until it becomes far too long and cumbersome. Far better, I think, to stick to a tested standard clause and add only those terms that are necessary to vary unwanted default rules or to reflect the specific intent of the parties.

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Comments

  1. Excellent article Michael. This whole area is a minefield and you certainly do not want to be going to court over part of the process that was menat to avoid court in the first place.

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