Drafting an ADR ClauseGuidance for the Transactional Lawyer 1

How does one go about drafting an ADR clause? What considerations should one think about? What are some of the options? The goal of this paper is to provide guidance for the transactional attorney (the “Draftsman”) about how to approach the task of drafting an ADR clause.

Why Bother with an ADR Clause?

Before embarking on a discussion about the task of drafting an ADR clause, one should ask a very reasonable threshold question – why bother? At least five objections can be raised against including a pre-dispute ADR clause in a contract. First, the parties can discuss ADR after a problem develops, if it ever does, so why bother including an ADR provision in a contract? Second, the time and effort expended in the process of negotiating an ADR clause is almost always wasted because most contracts in fact do not end in dispute. Third, the potential friction between the parties associated with negotiating an ADR clause does not warrant the speculative benefits. It is better to reserve the effort and risks for other, more important issues between the parties. Fourth, it is bad for the negotiation of any deal to inject the suggestion that problems will arise. Doing so is similar to introducing the idea of a pre-nuptial agreement into the discussions about marriage, thereby suggesting that one party is already planning for a divorce before the vows have been taken. Fifth, unintended consequences can flow from an ADR clause, even if well written; as good as a Draftsman is, she or he cannot anticipate every contingency, and as such, a dispute resolution process might end up being worse than nothing at all. With respect to an ADR clause that includes the obligation to arbitrate,

1 By Kendall C. Reed, LL.M., IMI, C.Arb, Mediator, Arbitrator, and Counselor at Law, based in Los Angeles, California, ken@kendallreed.com, with assistance from Rebecca Callahan, Esq., Attorney, Mediator and Arbitrator based in Irvine, California, and Eric Van Ginkel, Mediator, LL.M., Mediator and Arbitrator based in Los Angeles, California. ©2012.

1

several additional objections can be raised which are discussed separately below.

Although there is some truth to each of these objections, the author believes these objections are not sufficient to lead to the conclusion that an ADR clause should be avoided. First and foremost, the appropriate point in time to negotiate a dispute resolution procedure is before a dispute arises. As a matter of human nature, parties who are in the midst of creating a deal are usually in a cooperative frame of mine and, in contrast, parties in the midst of dispute are usually in a combative frame of mind. Also, just as with the classic objection to mediation, parties could well be reluctant to suggest an ADR process after a dispute has arisen for fear that doing so would be taken as a sign of weakness. It is better to have a pre-existing ADR clause to which the parties can make reference and thereby avoid these impediments.

An ADR clause should not be seen as either suggestive or causative of future disputes, but rather should be seen from a broader perspective as an effort to prevent the natural course of dispute escalation, encourage productive engagement, and foster de-escalation. In this regard, an ADR clause should be seen as a form of ADR system design, as appropriate to the specific circumstances of the contracting parties. Of dispute resolution system design generally and apropos to the current discussion, Allan J. Stitt has said:

“Organizations can design conflict management systems to deal with…disputes in a productive way that preserves rather than destroys relationships. Instead of resorting to litigation, strikes, work to rule, or withdrawing, disputants can use dispute resolution process that will resolve their conflict efficiently and effectively. Designing an Alternative Dispute Resolution (ADR) system can help improve communication, reduce costs, maximize efficient, and preserve or improve relationships.”2

An ADR clause can also be seen in a broader context as an effort at risk avoidance and mitigation, two pillars in the field of risk management, which

2 Stitt, Allan J., Alternative Dispute Resolution for Organizations; How to Design a System for Effective Conflict Resolution, John Wiley & Sons Canada, Ltd., Toronto, 1998, p. 2.

2

efforts are very much within the scope of responsibility for transactional attorneys.

The risk of that an ADR clause might “miss the mark” and create bigger problems is not a valid objection. Such is the type of risk transactional attorneys deal with every day. The solution is to understand what is involved and address the potential risks and rewards directly.

A Brief Look at Arbitration Clauses in Particular

Focusing specifically on arbitration, a study published by RAND3 in 2011 found that while businesses include arbitration clauses in over 75% of their consumer and employment contracts, only 6 percent include such clauses in their business-to-business/non-consumer contracts. Chief among the reasons given for not favoring pre-dispute arbitration clauses in commercial contracts were no right to appellate review in the courts; the fact that arbitrators are not confined to legal precedent; lack of confidence in the arbitrator’s neutrality, especially with “repeat players;” the belief that arbitrators are unwilling to make tough decisions and thus resort to “splitting the baby;” and the belief that arbitration is not less expensive or more expedient than litigation. While there are valid reasons for not preferring arbitration over litigation, the simple fact remains that 95% of all civil litigation matters are resolved without a trial and that over 60% of those resolutions are through settlement. That suggests two things: One, that parties should make an effort early on to discuss and resolve their differences and thereby avoid the professional fees and costs associated with discovery, law and motion and trial preparation activities. Two, that the right to a jury trial and the right to appeal are over rated as a reason for not wanting to submit a dispute to private arbitration because very few cases make it to trial (and fewer still are decided by juries), and of the cases that make it to trial, very few judgments are appealed (and fewer still are reversed).

3 Shontz, Douglas, Fred Kipperman, Vanessa Soma, “Business to Business Arbitration in the United States; Perceptions of Corporate Counsel.” (RAND Institute for Civil Justice 2011).

3

For example, the California Judicial Council maintains statistics regarding the courts’ workload and publishes those statistics on an annual basis.4 For fiscal year 2009-2010, over 10 million actions were filed, of which approximately 1.2 Million were civil actions and approximately 8.2 million were criminal actions. Of the 1.2 million civil actions, only about 220,000 were “unlimited jurisdiction” cases, meaning disputes in which the claimed damages were in excess of $25,000. Of those 220,000 “unlimited” civil cases, only 25,500 (or about 11%) were tried, and of those 1,400 (or less than 1%) were decided by a jury.

With regard to appeals, the statistics collected by the California Judicial Council also publishes statistics and “trend reports” that provide a ten-year perspective.5 The Judicial Council’s ten-year statistics concerning outcomes at the appellate level shows that approximately 20 to 25 percent of the matters decided result in reversal of the trial court, but that percentage is really 10 to 12 percent when compared to total appeals filed because approximately half of all civil appeals filed are resolved without a decision by the court (meaning they are dismissed, abandoned or settled). Additionally the statistics for “civil” appeals does not distinguish between “limited” and “unlimited” cases and thus include all civil matters.

It is true that the arbitration is lately taking longer than in the past and it is also true that the cost advantage of arbitration over litigation has been going down. These trends are associated with the behavior of parties and counsel in general in that both have come to expect and demand more litigation-type procedures as part of the arbitration process.6 However, the “keys to this cabinet” are truly held by the parties and counsel themselves. Being that arbitration is a process founded upon agreement and the parties are free to fashion a process that works for them, they are free to agree upon faster time

4 http://www.courts.ca.gov/627.htm.5 2011 Court Statistic Report, Statewide Caseload Trends 2000-2001 Through 2009-2010, Judicial Council of California/ Administrative Office of the Courts, http://www.courts.ca.gov/documents/2011courtstatistic reprot.pdf.6 See Stipanowhich, Thomas J., “Arbitration: the ‘New Litigation,’” 2010 U. Ill. L. Rev. 1 (Jan. 2010). See also, Stipanowhich, Thomas J., Editor-in-Chief, Curtis E. Von Kann, Deborah Rothman, Associate Editors, Protocols for Expeditions, Cost-Effective Commercial Arbitration: Key Action Steps for Business Users, Counsel, Arbitrators & Arbitration Provider Institutions, College of Commercial Arbitrators, 2010.

4

limits and greater efficiency. Also it is to be noted that in some states the relative difference between the length of time it takes to get to trial and the length of time it takes to get to an arbitration hearing has begun to move back more in favor of arbitration, not because of any change with respect to arbitration, but because of funding problems for the courts and the hugely disproportionate number of criminal case filings as compared to civil actions.

It is important to note that arbitration is the norm in one context, and this is the international commercial context. A significant reason for this is the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York, 10 June 1958) 7 (the “New York Convention”), which is codified in Chapter 2 of the of the Federal Arbitration of 1925, as amended8 (the “FAA”). The New York Convention is one of the more successful international treaties ever created and has been ratified by more than 140 countries out of a total number of approximately190, including virtually all of the countries of commercial importance.9 The significance of the New York Convention is that it requires signatory countries to enforce as binding both a contractual requirement for arbitration and any resulting arbitral award, in accordance with national law, consistent with the provisions of the Convention.10 To emphasize the point, for businesses based in the United States, an arbitration award arising from an international commercial arbitration is enforceable in most countries around the world, where a judgment from a United States court would not be; in the absence of an arbitral award, a party who has a judgment rendered in its favor by a US court would generally need to rely on the principles of comity.11

7 The New York Convention is the “keystone” upon which the entire edifice of international Commercial arbitration is built. Moses, Margaret L., Introduction by Eric E. Bergsten, The Principles and Practice of International Commercial Arbitration, Cambridge University Press, New York, 2008, p. xiii.8 9 U.S.C. §201, et seq. 9 Countries that have not ratified the New York Convention as of May 2011 include: Angola, Belize, Bhutan, Burundi, Cape Verde, Chad, Comoros, Congo, Equatorial Guinea, Eritrea, Ethiopia, Gambia, Grenada, Guinea-Bissau, Guyana, Iraq, Kiribati, North Korea, Kosovo, Libyan Arab Jamahiriya, Lichtenstein, Malawi, Maldives, Micronesia, Myanmar (Burma), Namibia, Nauru, Palau, Papua New Guinea, Saint Kitts and Nevis, Saint Lucia, Samoa, Sao Tome and Principe, Seychelles, Sierra Leone, Slovenia, Solomon Islands, Somalia, Sudan, Suriname, Swaziland, Taiwan, Tajikistan, Timor Leste, Togo, Tonga, Turkmenistan, Tuvalu, Uganda, Vanuatu, and Yemen. 10 Moses, supra, p. 203.11 “’Comity refers to the spirit of cooperation in which a domestic tribunal approaches the resolution of cases touching the laws and interests of other sovereign states. The rational for comity is deference to the foreign country’s legal, judicial, legislative, and administrative system of handling disputes over which it has jurisdiction, in

5

Two Basic Types of ADR Clauses

While there is no one-size-fits-all ADR clause,12 there are two simple questions that will help define which basic type of ADR clause or clauses should be included in any particular contract, those that are essentially consensual and those that provide for a binding decision by a third party:13

1. If a dispute were to arise between the contracting parties, is their relationship such that they want to have an opportunity to talk about the problem and get their respective key decision makers involved in trying to find an amicable resolution before surrendering the determination of the outcome to a judge, jury or arbitrator? If so, the parties should focus on a mediation and/or negotiation clause.

2. If a dispute were to arise between the contracting parties, do they want to completely avoid the court system because they value privacy,14 avoid the creation of case precedent, have a subject matter expert as the decision maker, avoid the potential for a “run-away” jury verdict, and/or provide for finality? If so, the parties should focus on an arbitration clause.

At a minimum, the inclusion of an ADR clause in a contract assures that the parties will retain control over the process by which a dispute is resolved – or resolution is explored - if indeed a dispute arises during the course of the contractual relationship.

a spirit of international cooperation.” Levy, David J, Editor, International Litigation: Defending and Suing Foreign Parties in U.S. Federal Courts, American Bar Association, 2003, p. 15012 There is no such thing as a “one-size-fits-all” ADR clause. Different situations present different risks and potential rewards and, at the very least, it is important for the Draftsman to understand the issues in play. That said, “off-the-shelf” clauses do exist, and such ADR clauses can sometimes be either appropriate for a given circumstance or a very good starting point for a more detailed and nuanced negotiation and drafting process. Examples of such ADR clauses can be found on the websites of JAMS, the American Arbitration Association, and sometimes in standard contracts promulgated by professional associations, such as the American Institute of Architects. The Draftsman is strongly cautioned against "cutting and pasting" ADR clauses from pre-existing contracts without thought or consideration for the circumstances of a new contract.13 There is third basic type of ADR clause which is a combination of these first two, and typically this third type is called a “stepped” or “tiered” ADR clause. This third type of clause will not be discussed directly in this paper.14 In the sense of there being no public record.

6

Drafting a Negotiation Clause

When drafting an ADR clause that requires negotiation, the Draftsman has nine basic issues to consider, and these are:

1. Whether the requirement for negotiation is a mandatory obligation or precatory;

2. Whether negotiation in “good faith” is to be required;3. Which disputes are to be included within the scope of the obligation;4. What is the trigger for the obligation to negotiate;5. When is the obligation to negotiate finished;6. Who are the required participants;7. What is to be done about provisional remedies during the negation

process;8. What is to be done about any relevant statute of limitations; and9. What are the next steps if the negation is unsuccessful?

1. Mandatory Obligation or Precatory Language

To what extent will the contractual requirement for negotiation be mandatory or merely precatory? As a technical matter, it would be difficult to create a mandatory requirement for negotiation that is enforceable on an action for specific performance. On the other hand, a precatory “obligation” to negotiate can still have a beneficial effect on how the dispute is dealt with by the contracting parties, perhaps by creating a sense of obligation arising from the pressure to act consistently with prior public statements.15 Also, it is possible to include language that creates some consequences for a failure to engage in a required negotiation process. A tangible consequence could be, for example, a deemed waiver of any claim for attorney’s fees on the part of the recalcitrant party if the document otherwise provides for attorney’s fees to the successful party in litigation.

15 Cialdini, Robert B. Ph.D., Influence, the Psychology of Persuasion, Quill, William Morrow, New York, 1984, pp. 56 – 113; the principle of “commitment and consistency.”

7

2. Good Faith

Should the requirement to negotiate include the obligation to negotiate in “good faith?” Certainly the concepts of “good faith” and “bad faith” are difficult to define as these concepts reference a certain frame of mind, and a requirement that the parties negotiate in good faith is essentially a requirement that they maintain the requisite frame of mind.16 Nevertheless, just as an “obligation” to negotiate can have a beneficial effect, an “obligation” to negotiate in good faith could have a beneficial effect on the parties’ behavior at the table. Compliance would likely be enhanced if the Draftsman included some measurable definition of what constituted “good faith,” such as participation by the proper people (see below) and that these people at least listen to the positions and arguments of the other party for a prescribed length of time. 3. Scope of the obligation to negotiate

Which disputes between the contracting parties are to be subject to the obligation to negotiate? Because the use of such a clause is likely to occur in the context of some tension between the parties, it is useful to draft a description of the included disputes with sufficient clarity to avoid a secondary dispute about the required scope of the ADR clause. Certainly issues involving the interpretation of and performance under the involved contract should be included. On the other hand, in certain situations it could be desirable to specifically exclude some disputes from the obligation to negotiate, such as, for example, issues of corporate authority or ownership of intellectual property. Or, it might be beneficial to include only certain issues within the obligation to negotiate, such as, for example, issues of warranty under a manufacturing contract.

4. Trigger for the Obligation to Negotiate

Parties negotiate every day. Given this, it is important to be able to distinguish between “garden-variety” negotiations and negotiation

16 Leslie, Douglas L., Labor Law in a Nutshell, West Group, St. Paul, 1979, p. 181.

8

contractually required to resolve a dispute. As such, it can be useful for the Draftsman to include language that creates a clear triggering mechanism, such as written notice between legal departments, or between divisional vice presidents, contracting officers, etc., whoever makes sense in terms of being likely to respond. Whatever the mechanism, the notice should, at a minimum, identify the nature of the dispute that is to be negotiated. As an aside, the simple act of clearly articulating a problem can sometimes have a beneficial effect on the course of a dispute.

5. Termination

Just as it can be useful to clearly identifying when the obligation to negotiate begins, it is likewise useful to define when the obligation ends. A drafting option can be to provide for written notice of termination. The clear advantage to this idea is flexibility. Another option is to set a specific time limit after the date of the initial written notice, such as, for example, thirty, sixty, or ninety days (subject to an extension by agreement). The advantage of this option is that it is automatic, and when dealing “next steps” (see below), the parties can avoid accidentally leaving open the obligation to negotiate.

6. The Participants

Who should participate in a negotiation? If the parties to a contract are natural persons and/or sole proprietors, this is not an issue, but if the parties are corporate entities, and especially if they are large organizations, this could be a very significant issue. At a minimum it should be required that those who participate possess the actual authority to agree to a solution. Additionally, it is generally a good idea to require participation by at least the level of management above where a dispute has arisen, and the Draftsman can create a functional definition along these lines. This approach has the advantage of flexibility, but the disadvantage of being imprecise and subject to interpretation, remembering that if a clause of this sort is triggered, it is likely to be within the context of an active dispute, and as such those involved are unlikely to initially be in an agreeable frame of mind. Another option is for the Draftsman to specify a person of a given rank within an organization, such as,

9

for example, the divisional vice president, or with a contract of sufficient importance, the company president/CEO. One benefit to this approach is, as a matter of human nature, the specter of involvement by a high ranking person with an organization can have a beneficial effect on the actions of those who are interacting on a day-to-day basis such that disputes are less likely to arise without good cause.

7. Provisional Remedies

What is to be done about provisional remedies, such as, for example, a request for a restraining order, attachment, or an injunction against the use of trade secrets? Where the situation is such that this could be important, then the Draftsman can create an unambiguous carve-out for such provisional remedies.

8. Statute of Limitations

What is to be done about an impending statute of limitations? The Draftsman can include language that automatically tolls the statute while the required negotiations are in process. If this is the approach adopted, then it is even more important to know when the process begins and ends. (See above).

9. Next Steps

What is to happen if a negotiation is unsuccessful? One option is for the ADR process to end, and the parties are then left to proceed as they please. If this is the intention, the Draftsman should specify this clearly. Another option is to provide for further ADR processes, such as mediation and/or arbitration, creating a “stepped” or “tiered” ADR clause.

Drafting a Mediation Clause

For purpose of drafting a mediation clause, most of the considerations discussed above with respect to a negotiation clause apply equally well, but substituting the word “mediation” for “negotiation,” including the issues of:

10

1. Whether the requirement for mediation is mandatory or precatory;2. Whether “good faith” is to be required;3. Which disputes are to be included with the scope of the requirement

for mediation;4. What is the trigger for the obligation to mediate;5. When is the mediation process finished;6. Who are the people who must participate in the mediation;7. What is to be done about provisional remedies during the mediation

process;8. What is to be done about any relevant statute of limitations; and9. What are the next steps if the mediation is unsuccessful?

There are four additional issues with respect to mediation clause that a Draftsman should consider:

1. What are the qualifications of the mediator to be;2. What should be done about the costs of the mediation process; 3. Should there be an exchange of information before the mediation;

and 4. What is to be done about confidentiality?

1. Qualifications of the Mediator

What are the qualifications for the mediator to be, if any? As a threshold matter, the mediator should have an appropriate level of experience. Certainly not every dispute requires a true master of the art, but neither should significant matters be placed in the hands of a novice. Of particular significance in this regard is the fact that experience as a mediator is gained only by time “at the table.” A legal background is not typically required. Many exceptional mediators have backgrounds in business, psychology, medicine, engineering, to name but a few. Subject matter expertise can be useful, but contrary to popular belief, mediation skills are generally more important and valuable than subject matter expertise. The Draftsman should provide some guidance about the qualifications for the mediator as may be appropriate to the circumstances of the involved contract and the disputes that are anticipated, but the Draftsman should also be cautious about being too

11

specific because the perfect candidate may not in fact exist, or if so, she or he might be booked for many months in advance.

2. Costs

Who is going to pay for the costs of the mediation process? Whereas it is free to negotiate, or at least costs nothing more than the time and attention of people already on the payroll, mediators are independent and must be paid. The Draftsman should consider including language about how the costs are to be divided between or among the parties, especially as an initial matter. Mediators typically require payment in advance, so who is to pay the up-front costs? An option is to put the burden of such up-front costs on the party who triggers the obligation to mediate, with the express reservation of the issue for the mediation. This allows the process to move forward without the need for the parties to agree about what could be a contentious issue. Another option is to provide for the parties to split all such costs.

3. Exchange of Information

Is information to be exchanged before a mediation session? At a minimum, the Draftsman should include a requirement that the parties exchange mediation briefs in advance of a mediation session. Beyond that, the parties could be required to exchange certain specific documents prior to the mediation session, for example, in a situation between parties who will be working under a master contract that contemplates the exchange of further order and acknowledgement documents, the parties should be required to exchange copies of the specific order and acknowledgment documents that are implicated.

4. Confidentiality

There is general agreement that mediation is a communication process in which the goal is a negotiated resolution of a dispute, or at least progress towards that end, with the mediator being tasked with the job of facilitating

12

constructive dialogue between or among disputants.17 The willingness of the parties to “open up” is critical to the mediator’s ability to engage parties in the problem-solving and negotiation aspects of mediation.18 As one authority put it, “Mediation is a communication process; solving legal problems is simply a byproduct.”19

It is generally believed by mediators that parties are less likely to open up and engage in forthright discussions unless they are confident that their statements will not be used against them later if the case does not settle. However, there is no recognized mediation privilege or duty that obligates mediation participants to maintain the confidentiality of what is said, done or exchanged in mediation. Best practices among mediators is to promise confidentiality insofar as their notes, work papers and actions are concerned, but most scholars have recognized that “as a legal matter, there is still considerable uncertainty about the extent to which communications made during the process of mediating a dispute are protected from disclosure in subsequent legal proceedings.”20 One authority has opined that “[c]urrently, it is not an overstatement to say that no mediator or counsel in the country can,

17 See SUZANNE MCCORKLE & MELANIE J. REESE, MEDIATION THEORY & PRACTICE 33 (2005).

Mediators listen to the disputants’ stories, allow them to vent their frustrations, validate each person’s worth and feelings, and provide appropriate feedback. Mediators are conduits of information. They allow parties to share information with each other and enable parties to understand each other’s perspective. Mediators keep communication focused on important and relevant issues. They help disputants discover and express their own interests and goals. Mediators are links to additional expertise, data, or resources that may be required to settle a dispute. They know the services available in their community and assist the parties to determine if outside, objective data are required. Mediators are boundary keepers when they frame issues, moderate emotions, and contain the conflict within a productive range.

Id.18 Alan Kirtley, The Mediation Privilege’s Transition from Theory to Implementation: Designing a Mediation Privilege Standard to Protect Mediation Participants, the Process, and the Public, 1995 J. DISP. RESOL. 1, 6 (1995); see also JAMES J. ALFINI ET AL., MEDIATION THEORY AND PRACTICE 205 (2d ed. 2006) (“Confidentiality is generally considered to be an essential ingredient in mediation.”); Sharp, supra note 5, at 223 (“Confidentiality is one of the keys to the acceptability and success of mediation among parties to a dispute.”).19 Kent L. Brown, Comment, Confidentiality in Mediation: Status and Implications, 1991 J. DISP. RESOL. 307, 309 (1991).20 See Kenneth R. Feinberg, Mediation—A Preferred Method of Dispute Resolution, 16 PEPP. L. REV. S5, 28 (1989); Note, Protecting Confidentiality in Mediation, 98 HARV. L. REV. 441, 446-47 (1984); see also Lawrence R. Freedman & Michael L. Pigroff, Confidentiality in Mediation: The Need for Protection, 2 OHIO ST. J. ON DISP. RESOL. 37 (1986).

13

with confidence, predict the extent to which it will be possible to maintain the confidentiality of a mediation.”21

While there are a number of statutes, rules, and cases that support confidentiality in mediation, they operate primarily as evidentiary rules with respect to what is admissible as evidence and who is competent to testify concerning statements made and information developed and exchanged in a mediation. The uncertainty about the nature and extent of what confidentiality protections exist for things said in mediation is especially apparent in federal court litigation disputes.22 For example, California has express statutory provisions that provide for confidentiality protections, and numerous Supreme Court of California decisions have endorsed those protections, but no similar protections are available to California litigants under federal law.23 Therefore, the confidentiality protections afforded California litigants with respect to communications had in mediation may depend on whether litigation is pending or ultimately filed in state or federal court. Additionally, because California’s statutory provisions protecting mediation are contained in the Evidence Code, it is questionable whether those protections apply in arbitration where rules of evidence are inapplicable unless the parties’ arbitration agreement provides otherwise.

In order to achieve the goals of mediation, the Draftsman should consider including language that provides for state law confidentiality protections to apply to the mediation and also creates specific contractual duties of confidentiality tailored to suit the parties and the nature of their anticipated disputes.

In drafting an ADR clause providing for negotiation and/or mediation, it is important for the Draftsman to ask the next question about what is to happen if

21 Ellen E. Deason, Predictable Mediation Confidentiality in the U.S. Federal System, 17 OHIO ST. J. DISP. RESOL. 239, 241 (2002).22 See Rebecca Callahan, Mediation Confidentiality: For California Litigants, Why Should Mediation Confidentiality be a Function of the Court in Which the Litigation is Pending?, __ PEPP. DISP. RESOL. J. ___ (2012); see also DWIGHT GOLANN, MEDIATING LEGAL DISPUTES 218-220 (2009); Dennis Sharp, The Many Faces of Mediation Confidentiality, in HANDBOOK ON MEDIATION 223-236 (2d ed. 2010).23 Callahan supra.

14

agreement is not achieved. As has been noted, this could be the end of the process, and thereafter the parties would be free to proceed as they like, but if so, this should be a conscious selection.

Drafting an Arbitration Clause

An ADR clause that includes an obligation to arbitrate is different from an ADR clause that creates obligations only to negotiate and/or mediate, as discussed above, because of the binding nature of arbitration. That said, some of the same drafting issues arise, as are discussed below.

The issues to be considered by the Draftsman with respect to an arbitration clause are:

1. What is the scope of the arbitrator’s powers;2. What should be the qualifications of the arbitrator(s);3. Should an arbitral institution be used;4. What rules should be used;5. Where should the arbitration take place;6. What should be the applicable laws;7. Should discovery be allowed, and if so, to what extent;8. What should the time limits be, if any; 9. Should the arbitrator’s award be reasoned;10.What should be done about provisional remedies; and 11.Entry of judgment.

1. Scope of the Arbitrator’s Powers

Two extremely important issues with respect to an arbitrator’s powers relate to: a) who can be bound by an arbitration award, and b) what issues can an arbitrator decide; the former is typically referred to as a matter of “jurisdiction” and the latter is typically referred to as a matter of “arbitrability.” If an arbitrator exceeds her or his power in an arbitration award in either respect, purporting to bind a person or entity not within the arbitrator’s jurisdiction or

15

including an issue that is not arbitrable, the award can be set aside, or “vacated.”24

In order to assure that a person or entity is within the jurisdiction of the arbitrator, it is essential for the Draftsman to make that person or entity a party to the arbitration agreement,25 whether she or he signs the underlying substantive contract or the arbitration agreement itself. The issues here typically relate to a person or entity against whom the Draftsman would ultimately want to enforce an arbitration award but who is not the main player in the underlying substantive contract, such as a guarantor or corporate parent. Sometimes and in the absence of a person or entity being a party to the arbitration agreement, this issue can be traversed though the application of agency principles or the doctrine of “enterprise liability,” where such is recognized, but these approaches should be seen by the Draftsman as positions of last resort and not of thoughtful risk management.

The Arbitrability of issues is determined from the language of the contract between the parties, and in construing the parties’ agreement to determine arbitrability, the law requires that questions of arbitrability “be addressed with a healthy regard for the federal policy favoring arbitration,”26 and that “any doubts concerning . . . scope . . . be resolved in favor of arbitration.” 27 Where arbitral claims are combined with non-arbitral claims, the court must separate the two and compel arbitration of the pendent arbitral claims even though the result might lead to parallel proceedings between the disputants in different forums.28

24 9 U.S.C. 10.25 A contract provision that creates an obligation to arbitrate is typically referred to as an “arbitration agreement,” and as a matter of a convenient and practical legal fiction, an arbitration agreement is deemed to be a separate agreement from the underlying substantive contract of which it is a part. If this were not true, then an obligation to arbitrate could be upended relatively easily, just at a time when the need for arbitration may be at its greatest. See 9 U.S.C § 2, Prima Paint Crop. v. Flood & Conklin Mfg., 388 U.S. 395, 402-406 (1967), and see also Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 4449 (2006). See also, Blackaby, Nigel, Constantine Partasides, with Alan Redfern and Martin Hunter, Redfern and Hunter on International Arbitration, 5th ed., Student Version, Oxford University Press, New York, 2009, p. 117. 26Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 631 (1985); Moses H. Cone Memorial Hospital v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983).27 Moses H. Cone, supra, 460 U.S. at 24-25.28 KPMG LLP v. Cocchi, 2011 DJAR 1635, 1636.

16

Determining arbitrability is a matter of contract interpretation and is decided by referring to the specific words used in the arbitration agreement to determine whether the clause is “narrow” – limited to contract claims arising under the contract – or “broad” – expanded to include tort and statutory claims that have their roots in the relationship created between the parties by the contract containing the arbitration clause. The most common “broad” form of arbitration agreement covers “all claims arising out of or relating to” the agreement.29 Likewise, the phrase “all disputes arising in connection with” the agreement has been interpreted broadly to encompass all disputes having a significant relationship to the contract, including antitrust violations, claims of misappropriation of trade secrets and defamation.30

The case law is clear that the above phrases are not essential to construing an arbitration clause to be a “broad” clause; that other wording may also result in such an interpretation. For example, in Vianna v. Doctors’ Management Co,31 an employment contract provided for arbitration of “any dispute of any kind whatsoever regarding the meaning, interpretation or enforcement” of the contract and was interpreted to be broad enough to cover both contract and tort claims arising during the employment relationship. The Court in Vianna relied on Merrick v. Writers Guild of America, West, Inc.,32 where the California Court of Appeal concluded that a contract provision requiring arbitration of “[a]ny dispute . . . concerning the interpretation of any of the terms of [the contract]” encompassed plaintiff’s malicious prosecution and abuse of process claims because they stemmed from and were not “wholly independent” of the parties’ contractual relationship.

It is important for the Draftsman to understand who decides the issue of an arbitrator’s powers, and this is because the Draftsman has some degree of control over this issue, at least with respect to questions of arbitratbilty. As a general rule, whether a particular dispute is within the scope of the parties’ arbitration agreement is presumptively a matter to be decided by the courts.33 In First Options, the Supreme Court articulated the rule that absent clear and

29 See, e.g., Larkin v. Williams, Woolley, Cogswell, Nakazawa & Russell, 76 Cal. App. 4th 227, 230 (1999).30 See, e.g., Simula, Inc. v. Autoliv, Inc., 175 F.3d 716, 720-725 (9th Cir. 1999).31 27 Cal. App. 4th 1186, 1189.32 130 Cal. App. 3d 212, 217 (1982).

17

unmistakable evidence of the parties’ contrary intent, courts – and not arbitrators – are to determine questions of arbitrability. Although the FAA has limited the role of the courts in the arbitration context, certain gateway issues have nevertheless remained within the purview of judicial review and determination.34 These gateway questions of arbitrability “typically involve matters of a kind that contracting parties would likely have expected a court to decide, such as the validity of an arbitration provisions, the scope of an arbitration provision, or whether an arbitration agreement covers a particular controversy.35

This is an evolving area of the law in which many courts have recognized the power of arbitrators to decide gateway issues. Reflecting the principle that arbitration is a contractual undertaking, the Supreme Court has recognized that parties can agree to have an arbitrator, rather than a court, decide questions of arbitrability in addition to deciding the merits of the parties’ underlying claims, provided that there is clear and unmistakable evidence of the parties’ intent to submit such disputes to arbitration.36 In First Options, the Court acknowledged that the issue of who may determine gateway issues to arbitration is “rather arcane” and something that a party often might not focus upon or appreciate the significance of having an arbitrator decide the scope of his or her own power.37 Given the principle that a party can only be required to arbitrate issues it specifically agreed to submit to arbitration, the Court explained that courts should hesitate to interpret silence or ambiguity as an expression of intent to have the arbitrator decide issues one would typically expect a judge, not an arbitrator, to decide.38 Nevertheless, some courts have found that when parties agree to have their arbitration governed by a particular institution’s rules and those rules provide for the arbitrator(s) to determine any disputes concerning arbitrability, the references to the rules will qualify as a

33 First Options of Chicago v. Kaplan, 514 U.S. 938 (1995); Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 83 (2002).34 Green Tree Financial Corp. v. Bazzle, 539 U.S. 444, 452 (2003).35 Id., see Howsam, 537 U.S. at 84.36 AT&T Technologies, Inc. v. Communications Workers, 475 U.S. 643, 649 (1986); First Options v. Chicago, Inc. v. Kaplan, 514 U.S. 938, 944-945 (1995).37 514 U.S. at 943-945.38 Id.

18

clear and unmistakable manifestation of their intent to have such matters determined by the arbitrator(s).39

The issue of a contract’s validity or enforceability is different from the issue of whether an agreement between the parties was ever concluded. Even with the jurisdictional backdrop of arbitration being a creature of contract in which mutual assent must be manifested, parties have nevertheless sought to compel arbitration even when the underlying contract containing the arbitration agreement was unsigned or unratified.40 The Supreme Court has recognized that there is a difference and a distinction to be drawn between challenges raised concerning a contract’s validity and challenges raised concerning the existence or formation of a binding agreement.41 The latter set of issues is for the courts, not an arbitrator, to decide, also when one party sues under an unratified or unsigned contract containing an arbitration clause.42 As the Supreme Court explained, the FAA’s pro arbitration policy “does not operate without regard to the wishes of the contract parties.”43 When the parties’ dispute is one that arises under the collective bargaining agreement, whether the subject contract was formed is a critical gateway issue and must be decided by the courts.44

The question of the arbitrator’s power to decide her or his own power45 is an issue primarily about who decides the issue first in time, the arbitrator or the court. In the final analysis the court is empowered to review the arbitrator’s decision about arbitrabiltiy under the FAA.46

39 See, AAA Commercial Rule R-7; CPR Rule 8; JAMS Rule 11(c). See, e.g., Shaw Group, Inc. v Triplefine Int’l Corp., 322 F.3d 115, 120-121 (2d Cir. 2003).; but see China Minmetals Materials Imp. & Exp. Co. v. Chi Mei Corp., 334 F.3d 274, 287-288 (3d Cir. 2003) (holding that incorporation of arbitral rules was insufficient to manifest an intent to have arbitrators decide arbitrabiltiy issues when party argued that arbitration agreement was forged) .40 See, e.g., Granite Rock Co. v. Int’l Brotherhood of Teamsters, __ U.S. __, 130 S.Ct. 2847 (2010) (collective bargaining agreement not ratified at time of strike); Sager v. Harborside Connecticut Ltd. Partnership, 2011 WL 2669240 (D.Conn. July 7, 2011) (agreement not signed); China Minmetals Materials Imp. & Exp. Co. v. Chi Mei Corp., 334 F.3d 274, 287-288 (3d Cir. 2003) (one party’s signature to contract allegedly forged).41 Buckeye, supra, 546 U.S. at 444 and n.1.42 Granite Rock, supra, 130 S.Ct. at 2859-2860.43 Id. at 2859.44 Id. at 2860-2861.45 In international practice, this is typically called the doctrine of “competence/competence,” in English, and “Kompetenz/Kompetenz,” in German. Blackaby (Redfern & Hunter), supra, p. 347.46 9 U.S.C. §9 and §10(d).

19

2. Qualifications of the Arbitrator

The Draftsman may want to be specific with respect to an arbitrator’s training and experience. This is one of the major advantages of arbitration over litigation; one can choose one’s decision-maker. However, like with the qualifications for mediators, the Draftsman should be cautious and avoid being too specific or impose too many requirements for the arbitrator. The perfect person may not exist or may be unavailable for long periods.

3. Use of an Arbitral Institution

The arbitrator could directly handle all of the administrative tasks that arise during the course of an arbitration proceeding, such as communicating with the parties about hearing dates, issuing orders, receiving pleadings and documents, organizing conference room space, etc. The additional fees and out-of-pocket costs resulting from such efforts would no doubt be charged back to the parties. An arbitration in which there is no administrating institution is called an “ad hoc” arbitration. On the other hand, arbitration proceedings are typically administered by and through an institution that is set-up to do these things efficiently. Such institutions also often have offices where an arbitration hearing can be conducted productively and comfortably. There are many such institutions, including the American Arbitration Association (“AAA”), Alternative Resolution Centers (“ACR”), JAMS, the London Court of International Arbitration (LCIA), the International Chamber of Commerce (“ICC”), the Hong Kong International Arbitration Center (“HKIAC”), etc. Such institutions tend to charge a fee for their services, over and above the arbitrator’s fees, and these fees must be taken into account when comparing the costs of the available options.

As noted above, most of these arbitral institutions also have their own rules, which provide a level of procedural detail that are both well-reasoned and time-tested. The selection of an institution can sometimes be driven by the desire for a certain set of rules.

4. Rules

20

The rules applicable to the process of arbitration typically relate to the details of procedure, such as:

- Notice and calculation of periods of time;- The number of arbitrators;- What is required in a statement of claim; - The procedure to be followed in filing further written statements;- Whether and how experts can be appointed by the arbitral

tribunal;47

- Disclosures required of arbitrators;- The authority of a panel to interpret the rules;- How to file motions;- A requirement that the parties cooperation in Discovery;48

- The requirement that the parties exchange of certain information;- Requirements for the form of an award;- The arbitrator’s authority to impose sanctions.49

There are many available sets of rules, and the parties are generally free to select any set of rules they wish,50 or the parties can create their own rules, although this is not recommended. In the absence of the designation of any set of rules, the details of procedure will be within the discretion of the arbitrator, although it is to be noted that most rules give wide latitude to arbitrators in any case, and as a practical matter, if an arbitration clause did not specify either a set of rules or an arbitral institution that had its own set of rules, the arbitrator would very likely exercise her or his discretion and promptly designate a set of rules.

5. Location of the Arbitration

The location of the arbitration hearing itself is first a matter of convenience for the parties. Often in the international context a primary

47 Examples from the UNCITRAL Model Rules, UN General Assembly resolution 65/22.48 Examples from the Financial Industry Regulatory Authority Cope of Arbitration Procedure of Customer Disputes as of May 3, 2010, www.finra.org; 49 Examples from JAMS’ Streamlined Arbitration Rules & Procedures, www.jamsadr.com. 50 See Volt Inf. Sciences v. Stanford University, 489 U.S. 468.

21

consideration is the neutrality of the location, such that neither party is a citizen thereof. Another consideration is typically the convenience of the parties, or at least equal inconvenience. Another very significant consideration is the extent to which courts within a given jurisdiction tend to become involved with arbitral proceedings. The ability to seek judicial support in furtherance of an arbitration proceeding can be very important, but too much involvement can be very problematic and amount to undesirable interference. Those jurisdictions which have a reputation for judicial meddling should be avoided.51

In the context of domestic US arbitrations, the location of the hearing tends to follow bargaining position and convenience of the parties, including the presence of a suitable arbitral institution that can supply facilities and other support.

Notwithstanding that convenience tends to be the primary driver for the selection of the location, this is not the only consideration. The Draftsman must be aware that the choice of a location typically defines the procedural law applicable to the arbitration process, especially in the international commercial context. This issue is discussed further below.

6. Applicable Law

The subject of the applicable law in the context of arbitration is complex. The Draftsman must be at least familiar with the issues and a specialist should be consulted if changes from the norm are being considered.

Other than in the context of arbitration, the topic of the choice of laws with respect to a contract is basically a question of specifying which laws will apply to the interpretation and performance of the contract. In the absence of an express clause, and when necessary, a court will generally apply a standard conflict of laws analysis in deciding which body of laws applies. In the

51 Paulson, Jan, Nigel Rawdin, Lucy Reed, Eric Schwarts, The Fresfields Guide to Arbitration and ADR: Clauses in International Contracts, Kluwer Law International, The Hague, 1999, p. 26.

22

context of domestic U.S. arbitrations, an express choice of laws provision applies only to issues of interpretation and performance of the contract.52

In the context of an arbitration clause, the Draftsman must also be concerned about an entirely separate body of laws, which is the law applicable to the arbitration clause itself and the procedure of the arbitration. This body of law relates to issues similar to the issues that may already be addressed by the applicable rules (see above), but generally with less specificity and more enabling provisions, such as:

- The definition and form of an agreement to arbitrate;- Whether a dispute is capable of being referred to arbitration;- The constitution of the arbitral tribunal and any ground of challenge

of that tribunal;- The entitlement of the arbitral tribunal to rule on its own

jurisdiction;- The requirement of equal treatment of the parties;- The parties freedom to agree upon detailed rules of procedure;- The arbitrator’s authority to issue subpoenas;- How interim measures of protection are handled during an

arbitration;- Statements of claim and defense;- Hearings;- Default proceedings;- The nature, extent and procedures for obtaining court assistance if

required;- The powers of the arbitrators; - The form and validity of the arbitration award, the finality of the

award, including any right to challenge it in the court of the place of arbitration.53

Which procedural law applies in the absence of an express selection by the parties (remembering that a standard choice of law clause likely does not operate as a section in this regard) depends upon whether the parties and/or the

52 Mastrobuono v. Shearson, Leham Hutton, Inc., 514 U.S. 53 (1995).53 Blackaby (Redfern & Hunter), supra, 177.

23

underlying transaction involve intrastate or interstate commerce. If the former, the law of the involved state applies, and if the latter, the FAA applies, perhaps augmented by state law as allowed by general principles of preemption and as defined by general principles of conflicts. However, given the support for the FAA expressed by the Supreme Court, the Draftsman should approach with skepticism the idea of an entirely intrastate context in which the FAA would have no force or affect.54

In the international commercial arbitration context, the applicable procedural law, and in the international context this body of law is typically called the “Lex Arbitri,” is defined by the country designated in the arbitration agreement as the location for the arbitration, which is typically called the “seat” of the arbitration. For example, an arbitration agreement providing that arbitration will take place in London will be governed by the English Arbitration Act of 1996, as amended,55 and an arbitration with its seat in Hong Kong will be governed by the Hong Kong Arbitration Ordinance.56 Parties typically have freedom to select the arbitral seat, and in this way they can readily select the applicable Lex Arbitri. It is to be noted that the parties need not actually meet within the country designated as the arbitral seat, and hearings can be conducted anywhere, but usually it is the procedural law of the seat that will apply and it is to the courts of the country of the seat that the parties would need to turn if judicial assistance was sought.

In the international context, parties could designate a procedural law other than that of the country specified in the arbitration agreement as the location for the evidentiary hearing, but to do so would be unusual and would likely lead to confusion, and in the event of judicial assistance, the “local” courts would be called upon to apply an unfamiliar body of law. This is not recommended.

7. Discovery

54 See Allied-Bruce Terminix Cos., Inc., v. Dobson, 513 U.S. 285 (1995).55 1996 C. 23.56 Chapter 609 of the law of Hong Kong.

24

Historically, discovery has not been allowed in arbitration, which has been one of the primary mechanisms for the advantages of speed and cost over litigation. On the other hand, no party in the common law tradition wants to be denied discovery. This sentiment has been recently expressed as follows: “Needless to say, discovery in most civil actions, particularly complex litigation, is crucial to assemble the evidence needed to win the case.”57 This is in contrast to parties from a civil law tradition, such as many countries in Latin America and continental Europe, where discovery is highly restricted.

The Draftsman has several options with respect to discovery. One option is to expressly provide for discovery pursuant to the federal rules of civil procedure or the rules of civil procedure of a state. This is not recommended as this would operate to push out the start of an evidentiary hearing and would push up the cost for the parties over what would otherwise be the case. Providing for full discovery would also constitute a missed opportunity for savings in both speed and cost. Another option is to follow the historic norm of not allowing for any discovery, which maximizes such savings. Another option is to adopt the International Bar Association Rules for the Taking of Evidence in International Arbitration,58 even in a domestic U.S. arbitration. These rules are an excellent effort to balance the competing interests for information, on the one hand, and efficiency, on the other. Another option is to allow for discovery “on good cause shown” to the arbitrator. This allows for some discovery as controlled by the person who will be making the ultimate decisions, and in allowing some discovery, she or he can be guided by what he or she might find persuasive. Another option is to specify in advance for a limited amount of discovery, such as, for example, two depositions and ten requests for production per side.

8.Time Limits

The Draftsman can include time limits. If nothing else and putting aside all considerations of the complexity of a given dispute, one of the drivers of

57 Olsen, Aaron M., Alreen Haeggquist, Introductory remarks to the section entitled “Discovery” in California Litigation Review; Review of 2010 Legislation and Developments, Litigation Section of the State Bar of California, November 2011, p. 7.58 www.ibanet.org.

25

cost in litigation is the length of time a case is pending. In this regard, time is truly money.

The Draftsman can create time limits with respect to the various stages of the arbitration process. The Draftsman can place a limit on the time an evidentiary hearing can begin after arbitration is initiated. The Draftsman can place a time limit on the completion of the evidentiary hearing after it begins. The Draftsman can create a time limit for the arbitrator to issue her or his award after the end of the evidentiary hearing. However, in creating time limits, the Draftsman must be careful. If a time limit operates to deny a party a reasonable request for a delay of the hearing or results in the arbitrator refusing to hear evidence pertinent and material to the controversy, this could be grounds for vacature.59 Also, if a time limit is missed, this would likely operate to strip the arbitrator of her or his power to render an award. Further, the existence of unrealistic time limits might be a deterrent against a potential arbitrator becoming involved in the first place.

9. A Reasoned Award

A reasoned arbitration award is one that details the arbitrator’s reasoning about the critical issues in the case and her or his findings of fact and conclusions of law, much like a reported appellate decision. This is in contrast to a non-reasoned award which simply identifies the prevailing party, the quantum of damages to be paid, if any, and other issues such as an award of attorney’s fees and the taxing of costs. Unless specifically required by agreement, law, or rule, an arbitrator is not required to give a reasoned award. If a reasoned award is desired, the Draftsman must clearly provide for this in the arbitration agreement, or alternatively, specify a set of rules that require a reasoned award. The Draftsman should be cautious, however, in providing for a reasoned award because they are time consuming to prepare and can consequently be very expensive.

The Draftsman should be aware that some types of arbitrations require a reasoned award in some jurisdictions, such as arbitrations of employment law

59 9 U.S.C. 10 (c).

26

disputes in California, where by case law the arbitrator must provide some kind of written decision explaining the result.60

10. Provisional Remedies

Arbitrators can issue provisional orders if provided with the authority by the parties in the arbitration agreement or the parties include by reference rules that include such an authority. On the other hand, the Draftsman may prefer to allow the parties to seek provisional remedies in court if, for example, the Draftsman foresees the need for quick action before an arbitration can be instituted and/or the Draftsman believes that a court would be better able to deal with the anticipated issues. Some jurisdictions allow for this right even without an express contractual provision, and the Draftsman should research this issue in the applicable procedural law.

11. Entry of Judgment

It is strongly recommended that the Draftsman provide that judgment upon an award rendered by the arbitrator may be entered in any court having jurisdiction. Without such language, an award will not be enforceable under the FAA.61

A Word about “Unconscionablity”

It has been said that a contract is akin to a private law between the contacting parties. It can similarity be said that an arbitration agreement is akin to a private court system the contracting parties will use to resolve an identified dispute. Today, federal and state courts are generally supportive of arbitration and will not interfere in the creation of a system, provided that the system does not violate any mandatory provision of applicable law. However, many courts have great difficulty when a stronger party attempts to create an arbitration system that clearly and systematically favors it or unreasonably disfavors the weaker party, primarily in the context of contracts of adhesion.

60 See Armendariz v Foundation Health Psychare Services, 24 Cal.4th 83 (2000).61 9 U.S.C. §9.

27

Such arbitration clauses can be and have been found to be unenforceable as being unconscionable, either substantively or procedurally. The Draftsman is free to practice what can be called the “art of the advantage” when drafting and arbitration agreement, as with any other contract provision, but the Draftsman should exercise extreme caution in this regard when the underlying contract is one of adhesion in the consumer context, and more generally whenever a significant disparity in bargaining power exists between the parties.

Conclusion

It is hoped this paper provides an answer to the question about whether an ADR clause is a good idea and provides guidance for the transaction attorney as she or he goes about the drafting task, always guided by the imperative for clarity.

Happy Drafting!

28