Litigation vs. Arbitration

A new article is out with more detail about how opinions among counsel for Fortune 1000 companies have changed over the last 15 years with respect to arbitration and mediation.  (I posted initial info here last spring.)

By comparing results of a 1997 survey of Fortune 1,000 corporate counsel with results of a 2011 survey of Fortune 1,000 corporate counsel, Professors Thomas Stipanowich and J. Ryan Lamare conclude that “[b]inding arbitration … reached its tipping point: while some longstanding concerns about arbitration processes have lessened, fewer major companies are relying on arbitration to resolve many kinds of disputes … and are evenly divided regarding its future use.”

In particular, the number of companies using arbitration to resolve disputes in the following areas dropped over that 15 year period: commercial, employment, environmental, intellectual property, personal injury, real estate and construction.  In some areas, the drop was significant.  In 1997, for example, 85% of companies had arbitrated a commercial or contract dispute in the past three years.  In 2011, that figure dropped to 62%.  In 1997, 62% of companies had recently arbitrated an employment dispute, and in 2011 that figure was about 39%.

The authors note that “the statistics meaningfully signal very different trends in mediation and arbitration.  Mediation usage is expanding and arbitration usage contracting in most conflict settings.  Key exceptions to the downward trend for arbitration are consumer disputes and products liability cases, which probably reflect expanded use of binding arbitration agreements in standardized contracts for consumer goods and services.”

Even if the companies had not recently used arbitration, would they use it in the future?  In 1997, 71% of counsel thought their company was likely or very likely to use arbitration in the future.  By 2011, only about 50% of counsel saw arbitration of corporate disputes in their future.

Why are corporate counsel less enamored with arbitration?  Data from the 2011 survey suggests that “leading concerns included: the difficulty of appeal, the concern that arbitrators may not follow the law, the perception that arbitrators tend to compromise, lack of confidence in neutrals, and, increasingly, high costs.”

The Third Circuit just issued a decision that tries to divine the dividing line between challenges to the formation of contracts containing arbitration clauses (which are presumptively for courts), and challenges to the validity of contracts containing arbitration clauses (which are presumptively for arbitrators, if the challenge is to the contract as a whole).  It held that an allegation that a contract is void because the signatory was not authorized to enter into that contract “must be decided by a court.”  SBRMCOA, LLC v. Bayside Resort, Inc., __ F.3d __, 2013 WL 491254 (3d Cir. Feb. 11, 2013).

The case involved claims by a condominium association on the island of St. Thomas against the developer.  A relevant agreement between the parties contained an arbitration clause, so the defendants moved to compel arbitration.  In response, the association argued that its Board did not have authority to enter into that agreement, making the arbitration clause unenforceable (along with the rest of the agreement).  The district court compelled arbitration, finding that an arbitrator should determine whether the Board had authority to execute the agreement.

The Third Circuit vacated the district court’s opinion, holding that the district court must decide the ultra vires argument on the merits.  It noted that the majority of federal appellate courts have concluded that courts should decide whether parties had authority to contract (the 11th, 2nd, 5th, 7th, 9th, and 3d Circuits), while only the Sixth Circuit has issued a contrary decision.  The court also found that additional discovery is warranted regarding the authority of the Board.

In contrast, the Third Circuit found that the association’s alternative claim, that it was coerced into executing the agreement, was arbitrable because it is a challenge to the validity of the agreement, instead of the formation of the agreement.

So, if the contract is void because the Board did not have authority to sign it, that stays in court.  But if the contract is void because the Board was coerced into signing it, that issue is punted to the arbitrator.  That is the result under Buckeye Check Cashing.  Whether that result makes sense is a question for another day.

 

Did you know that you can form an arbitration agreement without ever using the word “arbitration”?  That’s what the Second Circuit held this week in Bakoss v. Certain Underwriters at Lloyds of London, __ F.3d __, 2013 238708 (2d Cir. Jan. 23, 2013).

Bakoss analyzed the clause in a disability insurance certificate providing what happens if the parties dispute whether the insured is “totally disabled.”  The certificate gives the insured and insurer the right to get an opinion from a doctor of their choice.  If the two doctors disagree, they “shall [jointly] name a third Physician to make a decision on the matter which shall be final and binding.”  The legal issue was whether that agreement — to name a third doctor to decide the dispute — was an arbitration agreement within the meaning of the Federal Arbitration Act.  The federal district court found it was, and the Second Circuit affirmed.

Finding that federal common law was the right place to look in deciding what is and is not an arbitration agreement, the Second Circuit cited two cases from the 1980s finding that similar dispute resolution provisions were “arbitration agreements.”  In essence, those cases say that any time “the parties have agreed to submit a dispute for a decision by a third party, they have agreed to arbitration.”

Why is this important?  Because it means that many contracting parties have unknowingly inserted an “arbitration agreement” into their contracts, one which carries with it all the enforcement provisions of the FAA (and the New York Convention, for international contracts).  Just as one example, the parties to those contracts may have lost their ability to have a court decide whether the contracts as a whole are invalid under applicable law, because under the Prima Paint line of cases the court may only hear objections to the validity of the arbitration agreement itself.  Similarly, if these arbitration agreements do not contain any provision for class actions, the parties to these contracts may have lost their ability to bring any sort of collective action.

The Tenth Circuit this week refused to consider a plaintiff’s substantive arguments about its right to arbitrate because it found abstention was appropriate under the Colorado River doctrine.  D.A. Osguthorpe Family P’ship v. ASC Utah, Inc., __ F.3d __, 2013 WL 150221 (10th Cir. Jan. 15, 2013).  Though the factual situation in Osguthorpe is unusual, the decision highlights tension between the federal abstention doctrine and case law under the Federal Arbitration Act.

Osguthorpe involved a dispute over the development of a golf and ski resort in Utah.  The relevant parties included an arbitration clause within the Development Agreement.  However, when disputes initially arose, they were litigated in Utah state court.  After three years of state court litigation, one party (Wolf Mountain) moved to compel arbitration and the state courts (including the Utah Supreme Court) denied the motion after concluding Wolf Mountain had waived its right to arbitrate.  Before the Utah Supreme Court affirmed the waiver decision, however, D.A. Osguthorpe also moved to compel arbitration.  The state court denied Osguthorpe’s motion and Osguthorpe both appealed that decision in state court and filed a new action in the federal court seeking an order compelling arbitration and staying the state-court action.  Osguthorpe filed its federal case more than four years after it had initiated state court claims related to the same development, claims which had been proceeding in a consolidated case with related claims of other parties.

The federal district court dismissed Osguthorpe’s case for lack of subject-matter jurisdiction.  The Tenth Circuit affirmed.  After concluding that the Rooker-Feldman doctrine was not applicable in this case, the court held that “the Colorado River doctrine . . . mandates the dismissal of Osguthorpe’s suit.”  For those of you who, like me, avoided taking “federal jurisdiction” in law school because it had the dullest title in the course catalogue, I will summarize the Colorado River doctrine this way: sometimes federal courts can declare a lack of jurisdiction when there is a parallel state court proceeding that significantly overlaps with the proposed federal case.  In deciding whether to duck jurisdiction, courts have to analyze four factors.  The third and most “paramount” factor is “the desirability of avoiding piecemeal litigation.”  The Tenth Circuit leaned heavily on that third factor in its decision, relying on the incredible judicial resources that had already been committed by the Utah state court system in handling the protracted litigation over the five year period. (The state court case was “one of the greatest consumers of the resources of the [court] in many years” and “comprises more file volumes than any presently pending case in the [court].”)

In short, the federal court refused to exercise jurisdiction over Osguthorpe’s suit to enforce its right to arbitrate because doing so would entail piecemeal litigation.  How does that square with SCOTUS’ 2011 decision in Cocchi, saying in no uncertain terms that the point of the FAA is to enforce arbitration agreements, even if their enforcement results in piecemeal litigation?  Maybe the answer is that this case only relates to federal court jurisdiction, and it is up to the Utah state courts to enforce the Cocchi decision.  However, I can imagine cases where the conflict is more direct.  Seems like it would have consumed the same amount of federal judicial resources to hold that Osguthorpe had waived its right to arbitrate by participating in litigation for five years.

 

Let’s say you are considering updating your form contract, or you are in the midst of negotiating a new contract with someone.  Should you include mandatory arbitration for resolving any disputes?  Assuming you have the choice, my view is you should only include arbitration if at least one of these five factors are present:

1.  Having a knowledgeable industry professional decide the dispute is very important (an architect, engineer, doctor, reinsurance expert, etc), instead of a judge or jury without that expertise, because disputes are likely to be very technical.

2.  Keeping the proceedings confidential (and not publicly available in court filings) is very important to you.  (Although, if either party moves to vacate, much of your arbitration proceeding could become part of a court record.)

3.  You do not want class actions.  (They can be precluded in an arbitration agreement; it is less clear whether they can be precluded without an arbitration agreement.)

4.  You want to arbitrate because other parties on the same project or deal have arbitration provisions.  (For example, if the owner and general contractor on a construction project are bound to arbitrate, the owner and architect may also want to agree to arbitrate in case the architect is implicated in claims between the owner and general.)

5.  There is a chance that you may have to enforce a judgment in a foreign court.  The New York Arbitration Convention allows the winning party in an arbitration to enforce its judgment abroad much more easily than if the judgment had come from a U.S. court, which is important if the loser’s assets are located abroad.  [*Note that the original version of this post only included the first four reasons.  But I received useful feedback via Twitter and email about this additional benefit of arbitration over litigation and added it to the list.  Thanks for the input!]

It is a relatively short list.  But, in my view, these are the only four bases on which arbitration has a significant advantage over litigation.  You will note that speed of resolution is not on the list (unless parties opt for expedited proceedings, arbitrations generally take about as long as court proceedings — the median case valued between 1 and $10 million dollars administered by the AAA took 414 days to get to an award).  You will also note that cost is not on the list (in my experience on complicated commercial matters, there is no cost saving to arbitration and I found a recent study supporting my anecdotal evidence).  Speed and cost used to be the primary reasons people chose arbitration.

There are other potential reasons to choose arbitration that I am also discounting.  For example, the risk of an illogical jury verdict is not significantly greater in my mind than the risk of an illogical arbitration award.  I also do not see any advantage to the greater informality and looser rules in arbitration, or find it less adversarial.  And, although you can make someone conduct the arbitration hearing in the basement of your building, you could just as easily have a forum selection clause choosing your home town courthouse in most circumstances, so I do not count that as a big advantage for arbitration.

It’s the start of a new year and a great time to step back and revisit our reasons for inserting arbitration in our contracts.  I’d love to hear whether you agree or disagree with my list!  Let me know @KramerLiz.

Just a few months after its first Director took office in January of 2012, the Consumer Financial Protection Bureau is embarking on a study of arbitration.  The CFPB announced on April 24 that it invites the public to send information about “how consumers and financial services companies are affected by arbitration and arbitration clauses,” so that it can eventually determine whether to flex its rule-making muscle.

This request for information does not signal any particular bias of the new Director, Richard Cordray.  Instead, it shows the new agency is fulfilling its mandate under the Dodd-Frank Act to study the use of pre-dispute arbitration agreements in the consumer financial arena.

The agency, however, is starting its study with the speed of a tortoise and in the style of a professor wearing tortoise shell glasses.   Instead of diving right in, the CFPB is holding off its real study while it decides how to choose the questions.  For example, it is seeking information about 1) how to assess how prevalent pre-dispute arbitration agreements are in consumer financial agreements; 2) what data it should seek from what sources; and 3) whether it should find out whether consumers who arbitrated disputes against financial services companies were satisfied with the process.  (Let me publicly answer that last question: Yes!  Of course!  Please ask both consumers and companies whether they were satisfied with the process.)

While I am excited about the prospect of this new agency investigating and publicizing important data about consumer arbitrations that is currently inaccessible, the CFPB’s current list of questions makes me wonder whether it is up to the task.

 

A new survey found that Fortune 1,000 corporations are significantly less likely to arbitrate contract disputes today than they were in 1997.  In the 1997 study, 85% of companies reported using arbitration in commercial contract disputes at least once during the prior three years.  In 2011, however, only 60 percent of companies so reported.  In contrast, the companies’ usage of mediation remained steady at around 80%.

 The most common reasons given by survey respondents (general counsel and senior corporate lawyers) for not using arbitration included: the difficulty of appeal, the perception that arbitrators tend to compromise, the concern that arbitrators may not follow the law, a lack of confidence in neutrals, and high costs of arbitration.  The study, conducted through Cornell’s Survey Research Institute, was co-sponsored by Pepperdine’s Straus Institute for Dispute Resolution, Cornell University, and the International Institute for Conflict Prevention & Resolution (CPR).  (Its results are not currently available on-line.) 

I find it interesting that during this same time period—1997 – 2011—the Supreme Court has been making it more and more difficult for businesses to argue that their arbitration agreements are invalid (consider Buckeye Check Cashing, Rent-a-Center, Concepcion, etc.).  While those two trends may not be causally related, the end result is that the Supreme Court is strictly enforcing arbitration agreements at the same time that corporate counsel are growing less enchanted with arbitration. 

Many organizations and individuals are thinking of various solutions to the problems with arbitration identified in the survey, and legislators are brainstorming statutory solutions.  One interesting proposal to increase transparency about various arbitration programs is from Professor Thomas Stipanowich of Pepperdine University, who proposes an “Arbitration Fairness Index”: an independent system to rate and rank consumer and employment arbitration programs.

Although courts and practitioners may think of the Stolt-Nielsen decision as the death knell of class arbitration, the Third Circuit’s ruling last week serves as a reminder that the Stolt-Nielsen did not deal a mortal blow.  In fact, in Sutter v. Oxford Health Plans LLC, __ F.3d __, 2012 WL 1088887 (3d Cir. April 3, 2012), the Third Circuit affirmed an arbitrator’s decision to allow class arbitration based on an arbitration agreement that never mentioned class actions at all.

The arbitration agreement at issue in this dispute over medical reimbursements succinctly provided: “No civil action concerning any dispute arising under this Agreement shall be instituted before any court, and all such disputes shall be submitted to final and binding arbitration…”  (Before you criticize the drafters, let me point out that this agreement was executed in 1998, before the availability of class arbitration was a hot topic.)  The putative class of doctors initially brought their case in state court, and the court granted the insurer’s motion to compel arbitration, noting that the issue of whether the case could proceed on a class basis was for the arbitrator to determine. 

The arbitrator determined that the arbitration agreement allowed the doctors to proceed in arbitration as a class.  The arbitrator based his analysis on both the breadth of the arbitration agreement and the absence of any express carve-out for class arbitration, which led him to conclude the parties intended to authorize class arbitrations. 

After the arbitration proceeded on a class-wide basis, the insurer moved to vacate the arbitrator’s decision to allow the class-wide claim.  The insurer argued the arbitrator “exceeded his power” within the meaning of Section 10 of the FAA.  (It is probably safe to assume the insurer lost the arbitration, although the opinion does not say…)  The district court and Third Circuit both upheld the arbitrator’s decision. 

The extraordinary deference that courts grant arbitrators was critical to the decision; the Third Circuit noted that as long as an arbitrator “makes a good faith attempt” to interpret and enforce the contract, the court will not vacate the arbitrator’s decision.  Because the arbitrator in Sutter rooted his decision in an analysis of the text of the arbitration agreement, the court concluded “the arbitrator performed his duty appropriately” and his decision on class arbitration could not be vacated. 

This decision is important for other courts, counsel, and arbitratorswho are interpreting Stolt-Nielsen S.A. v. Animal Feeds Int’l Corp., 130 S. Ct. 1758 (2010).  The Third Circuit recognized that “an arbitrator may exceed his powers by ordering class arbitration without authorization,” but also addressed some misconceptions about Stolt-Nielsen.  Most critically, the court emphasized that “Stolt-Nielsen did not establish a bright line rule that class arbitration is allowed only under an arbitration agreement that…expressly provides for aggregate procedures.”  Instead, it “established a default rule” that parties may not be compelled to class arbitration unless the contract indicates the party consented to class arbitration.   

What is the distinction?  It is that courts and arbitrators should not use the presence or absence of magic words like “class arbitration” or “class action” as the basis to rule on the availability of class arbitration, but instead must carefully analyze the contract to determine the parties’ intent.  The “default rule” mentioned in Sutter leaves the door open a smidge wider for arguments about the propriety of class arbitration than the “bright line rule”.  Just a smidge.

 

The Supreme Court of Arkansas has joined Florida, Ohio, and Arizona (at least) in holding that a non-lawyer is guilty of the “unauthorized practice of law” if he or she attempts to represent a corporation in arbitration proceedings.  Nisha v. Tribuilt Constr. Group, __ S.W.3d __, 2012 1034641 (Ark. Mar. 29, 2012).

Nisha involved a general contractor who claimed the owner owed it over $666,000 for completing construction of a hotel.  A year after the trial court compelled arbitration, the contractor’s counsel withdrew, and the contractor’s President sought to represent the company in the arbitration.  The owner objected and moved to enjoin the President from representing the contractor in arbitration, arguing that to do so constitutes the unauthorized practice of law.  The trial court found that the arbitrators, not the court, should decide whether the contractor could proceed without a lawyer, but certified the issue for immediate appeal.

The Supreme Court of Arkansas seemed offended that the trial court punted this issue to the arbitrators.  Just as the New York federal court noted in disqualifying lawyers from an arbitration, the courts have “exclusive authority to regulate the practice of law.”  After firmly claiming jurisdiction over the issue, Arkansas’s high court held that companies must be represented by lawyers, both in court and in arbitration.  The court cited two bases for its conclusion — first, Arkansas’s long-standing rule that corporations cannot engage in the practice of law through their officers, and second, “arbitration proceedings bear significant indicia of legal proceedings” and party representatives will make arguments, present evidence, and cross-examine witnesses.  Those two factors won the day, despite the court’s concern that arbitration is supposed to be cheaper than litigating in court.

Legitimate concern about the “unauthorized practice of law” comes up regularly in arbitration.  Not only for companies that may want to represent themselves, like the general contractor in Nisha, but also for out-of-state lawyers whose clients are contractually bound to arbitrate in another state (must I get admitted pro hac vice before the courts of Hawaii to represent a client at a hearing in Hawaii?  It might be worth it…).    Rule 5.5 of the ABA Model Rules of Professional Conduct (and its comments), and the relevant state’s equivalent rule, are the place to start for attorneys who are analyzing that issue.  Some mediators and arbitrators are also concerned that their work may be considered the “practice of law” and therefore need to be sanctioned by each state court where they offer dispute resolution services.   On top of these issues of how each state defines the practice of law, courts will likely have to consider the interplay of the FAA, and whether it preempts any state rules governing parties’ representation and choice of neutrals in arbitration.  For now, though, this area is in flux and parties must be cautious when analyzing their compliance with state rules governing the unauthorized practice of law.

The severability doctrine of federal arbitration law tells litigants that unless they can specifically challenge the validity of the arbitration provisions of the contract, as opposed to challenging the entire contract, the courts will not address the merits of the challenge.  (See entire line of increasingly harsh cases starting with Prima Paint and continuing through Rent-A-Center.)  But, there was always one big loophole – courts would always address arguments about whether any agreement was ever concluded at all.  The federal courts have been willing to decide claims (even though not specific to the arbitration provisions) that a party’s signature was forged, or an agent lacked authority to execute the contract, or a contracting party lacked legal capacity to contract, despite the presence of arbitration clauses in those contracts.  The Supreme Court confirmed in Granite Rock that issues of contract formation are reserved for the courts, not arbitrators.  Granite Rock Co. v. Int’l B’hood of Teamsters, 130 S. Ct. 2847, 2855-56 (2010).

The Eleventh Circuit has now narrowed the types of “formation challenges” that courts in its circuit can hear.  Solymar Investments, Ltd. v. Banco Santander S.A., __ F.3d __, 2012 WL 612302 (11th Cir. Feb. 28, 2012).  In Solymar, the plaintiffs alleged that they had agreed to a multi-part settlement of their Madoff-related investment fraud with the defendants.  After significant negotiation, the parties contemplated execution of multiple documents simultaneously.  However, the defendants convinced plaintiffs that one of the documents (the Exchange Agreement) needed to be executed quickly, and the others would follow. 

After execution of the Exchange Agreement, negotiations fell apart, and no further documents were executed.  The plaintiffs took the position that because only one of the contemplated documents was executed, there was no binding settlement and initiated a lawsuit.  In response, the defendants moved to compel arbitration based on the arbitration provision in the Exchange Agreement.  The district court compelled arbitration.

The Eleventh Circuit affirmed the decision to compel arbitration based solely on the Exchange Agreement.  Using the applicable state law (Florida’s), the court found that the Exchange Agreement was a complete and final document, and because the plaintiffs did not challenge the validity of its arbitration provisions in particular, they must be enforced.  The court refused, however, to address the merits of the plaintiffs’ claims that the Exchange Agreement was invalid because it was intended to be one aspect of a broader scheme of agreements.  Without much analysis, the court found that issue was not properly characterized as “formation” but instead of “validity,” and therefore it was in the province of the arbitrator. 

Although this particular issue is not likely to arise frequently, it shows that even formation challenges may be construed very narrowly under the current Supreme Court precedent, and that the line separating formation challenges from validity challenges may not be neatly drawn.