Arbitration Pitfalls – Failing to Specify Who Decides Arbitrability

Arbitration Series – Part 1 of 3:  Agreements to arbitrate are often viewed favorably during contract negotiations as way to avoid litigation and minimize costs and expense should a dispute arise between the parties. Frequently, however, arbitration may be just as expensive and lead to uncertainties and consequences never contemplated. A party should carefully consider and understand the terms of any arbitration clause and avoid rubber stamping general arbitration clauses, such as those calling for the arbitration of any dispute arising under or relating to the contract under the Rules of the American Arbitration Association (“AAA”). One threshold issue the parties should clearly understand and address is who will have jurisdiction to resolve disputes about whether a given claim falls within the scope of the parties’ arbitration agreement.

The U.S. Supreme Court has ruled that the question of whether a particular dispute is arbitrable is presumptively a question for the court to decide absent “clear and unmistakable” evidence that the parties agreed that the arbitrator would decide this question. First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 944-45 (1995). Following this decision, arbitration associations amended their arbitration rules to provide that the arbitrator has jurisdiction to decide whether a given dispute is arbitrable. Rule R-7 of the AAA Commercial Arbitration Rules, for example, provides that the arbitrator “shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement or the arbitrability of any claim or counterclaims.” All the various sets of arbitration rules promulgated by the AAA now contain a similar rule. A line of cases from federal district and circuit courts subsequently developed (now the majority view) holding that when the parties use a broadly worded arbitration clause incorporating a set of arbitration rules which confers upon the arbitrator the power to determine his own jurisdiction, they “clearly and unmistakably” agree to arbitrate whether a given dispute is arbitrable. Oracle Am., Inc. v. Myriad Group A.G., 724 F.3d 1069, 1071 (9th Cir. 2013); Petrofac, Inc. v. DynMcDermott Petroleum Operations Co., 687 F.3d 671, 674 (5th Cir. 2012); Fallo v. High-Tech Inst., 559 F.3d 874, 876 (8th Cir. 2009); Qualcomm Inc. v. Nokia Corp., 466 F.3d 1366, 1369 (Fed. Cir. 2006); Terminix Int’l Co. v. Palmer Ranch Ltd. P’ship, 432 F.3d 1327, 1329 (11th Cir. 2005); Contec Corp. v. Remote Solution, Co., Ltd, 398 F.3d 205, 208 (2d Cir. 2005). Thus, where a dispute, whether sounding in tort, equity, contract or statute has any arguable connection to the agreement, the arbitrator instead of the courts may have the power to determine if the dispute is arbitrable.

It is important to recognize that arbitrators are usually private practitioners engaged in the business of providing legal services for a fee. They may face significant financial and competitive pressures to earn more money and handle more cases. That is true for many arbitrators suitable for commercial disputes, but is not the case for the judiciary. Most parties would expect that a judge’s compensation does not depend on how that judge decides an issue, but they may not appreciate that conferring the power on an arbitrator to determine whether a given dispute is arbitrable or not could have such an effect.

Where parties only intend to arbitrate certain types of disputes but want to have those specific disputes, and only those disputes, resolved by an established arbitration organization and under its established arbitration rules, it is critical that the parties carefully define and narrow what disputes are arbitrable. Unless parties want to arbitrate whether a given dispute is in fact arbitrable, they should also specifically address in the body of the arbitration clause itself the question of who will determine whether a given dispute falls within the scope of their arbitration agreement. The same applies if the parties intend an arbitrator to decide whether a given dispute is arbitrable. Failure to do so may lead to complicated and expensive disputes concerning the scope of the arbitration clause or lead to results the parties never focused on or intended.