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Small Business B-2-B Arbitration Part II.B: How Arbitration Agreements Work

October 17th, 2013 Arbitrability, Arbitration Agreements, Arbitration Practice and Procedure, Authority of Arbitrators, Awards, Drafting Arbitration Agreements, Making Decisions about Arbitration, Practice and Procedure, Small Business B-2-B Arbitration Comments Off on Small Business B-2-B Arbitration Part II.B: How Arbitration Agreements Work By Philip J. Loree Jr.

Part II.B.1: Delegating Authority

The Arbitration Agreement and the Submission

If you’ve followed this series from inception you already know that the decision to agree to arbitrate disputes arising out of a transaction, and if so, under what terms, can be as important as any other decision a business must make about price and performance terms. Armed with sufficient knowledge about how arbitration and arbitration-law works, business people and their lawyers can make better-informed choices about arbitration, including whether seeking advice from an attorney with arbitration and arbitration-law experience is warranted in the circumstances. All else equal, a business that makes informed choices about transaction terms—including dispute resolution terms—increases the odds that the transaction will work as the parties intended.

Knowledge of how arbitration agreements are structured and how they work is essential to appreciate the risks and benefits associated with arbitration. Part II.B of the series is designed to introduce the basics of pre-dispute-arbitration-agreement structure and function. This Part II.B.1 focuses on the nature of the pre-dispute promise to arbitrate, how that promise is implemented by the post-dispute submission and the nature and extent of the power parties delegate to an arbitrator by way of their submission.

The Pre-Dispute Arbitration Agreement: A Promise to Submit Disputes to Arbitration

Most pre-dispute arbitration agreements are simply mutual promises to submit to an arbitrator or panel of arbitrators a narrowly or broadly defined universe of disputes or types of disputes that might arise in the future. Sometimes the agreement designates an arbitrator or panel of arbitrators to whom disputes will be submitted; other times it sets forth a procedure by which the parties appoint arbitrators each time a party demands arbitration, which enables the parties the opportunity to select the arbitrator or panel they believe best suited to resolve the particular disputes to be determined in a particular arbitration proceeding.

The mutual promise to submit disputes to arbitration, and the universe of disputes that must be submitted, is frequently set forth the agreement’s opening sentence, which might, for example, say something like: “A and B agree that any dispute arising out of or relating to this Agreement shall be submitted to arbitration. . . .” The rest of the agreement typically defines the “who, what, when, where and how” aspects of that promise, including: (a) who the arbitrators will be, or at least how they will be selected and what qualifications they must have; (b) where the hearings will take place; (c) what procedural rules, if any, will govern the arbitration; (d) what decisional principles, norms and customs— if any—the arbitrators may or should follow in making their awards; (e) how awards will be judicially enforced, including, for example, consent to entry of judgment upon them (i.e., consent to confirmation); (f) where enforcement proceedings may be brought, including the designation of one or more courts and consent to personal jurisdiction; (g) what conditions precedent, if any, a party must satisfy before submitting a dispute to arbitration, such as pre-arbitration negotiation or mediation; and (h) practically any other term or condition concerning arbitration, including whether the arbitration will be administered by an arbitration provider. Sometimes these terms are supplemented by the incorporation by reference of rules, policies or other materials, which themselves become part of the arbitration agreement. And sometimes contractual provisions relevant to the parties’ arbitration agreement appear elsewhere in the contract, such as choice-of-law and choice-of-forum provisions.

An arbitration agreement may be evidenced by a separate,  written, fully integrated contract that deals only with arbitration, or it may be subsumed within the parties’ main contract in the form of an arbitration clause.  As will be discussed in a later installment of this series, however, arbitration agreements are generally deemed to be separate and independent from the agreement creating the legal relationship to which they relate.  We therefore usually use the term “arbitration agreement”—rather than “arbitration clause” or “arbitration provision”—to describe both standalone arbitration agreements and arbitration clauses contained in a contract covering a broader range of topics.

Whether standalone or part of a larger agreement, pre-dispute arbitration agreements are usually not self-executing in the sense that arbitration cannot proceed without a submission.  Typically the parties simply establish an agreed framework for what will transpire in the event a dispute falling within the scope of the arbitration agreement arises and one of the parties elects to commence arbitration proceedings.  Until a party demands arbitration of a dispute, the pre-arbitration agreement is simply a contingency plan. It confers no authority on an arbitrator in and of itself, even one designated to serve as the arbitrator for whatever disputes, if any, may arise over the duration of the legal relationship created by the parties’ main contract.

Since a pre-dispute arbitration agreement is essentially a mutual exchange of executory promises (i.e., promises to perform an act in the future), its performance occurs when the parties actually do what they promised to do—submit disputes to arbitration. Submitting a dispute to arbitration means defining the issue to be arbitrated and explicitly authorizing the arbitrator to decide the issue by requesting her to do so. The act of submitting a dispute to arbitration is the performance or execution of the arbitration agreement as respects that dispute and is commonly referred to as the submission.

The submission is a supplemental post-dispute arbitration agreement the parties expressly or by their words and conduct enter into when they request arbitral intervention. It is the parties’ presentation of a particular dispute or issue to a particular arbitrator for resolution, and may be in the form of a written agreement or evidenced by a combination of the arbitration demand, the response to the demand, and the parties’ position statements, briefs and other written and oral statements made during the proceedings. It implements the parties’ pre-dispute arbitration agreement as respects the particular disputes that one or both of the parties believe must be adjudicated by a neutral decision maker through advesarial proceedings.

From the standpoint of contract law the submission is  effectively a trilateral contract among the parties and the arbitrator as respects the disputes the parties conditionally or unconditionally consent to the arbitrator resolving. The party demanding arbitration requests the arbitrator to resolve the dispute in the manner set forth in the pre-dispute arbitration agreement and the arbitrator accepts that offer by agreeing to do so in exchange for payment of her arbitrator’s fee. The demanding party also requests the other party to proceed to arbitrate that dispute in the manner set forth in the pre-dispute arbitration agreement.  The other party accepts the offer to arbitrate by either: (a) unconditionally by proceeding to arbitration without objection; or (b) conditionally by proceeding to arbitration under a reservation of rights to seek a post-award judicial determination of whether it was required to submit the dispute to arbitration. (If state law rather than the FAA applies, it might require the other party to seek a stay of arbitration rather than proceeding with arbitration on a conditional basis.)

If the other party refuses to arbitrate the dispute even on a conditional basis, then what happens next is determined by the terms of the pre-dispute arbitration agreement and applicable arbitration law. If the pre-dispute agreement permits arbitration to proceed in the absence of the other party, then generally the demanding party will have to proceed to arbitration without the other party, and if the demanding party receives a favorable award, the opposing party will be permitted to seek a court determination of whether it was required to arbitrate the dispute. If the arbitration agreement does not provide for arbitration to proceed in the absence of both parties, then the demanding party may  seek, or may even be required to seek, judicial intervention in the form of a motion or petition to compel arbitration, and the court will determine if the party refusing to arbitrate was legally obligated to submit the dispute to arbitration, and if so, order it to submit the dispute to arbitration.

Another important aspect of the submission is that the other party is entitled to ask the arbitrator to decide other disputes that may fall within the scope of the arbitration agreement.  If the other party elects to do that, the demanding party will either proceed to arbitrate those disputes conditionally or unconditionally, or, if the terms of the pre-arbitration agreement permit it to do so, to seek a judicial determination of its obligation to submit those disputes to arbitration. Since the demanding party typically wants arbitration of its dispute to proceed without delay, generally the demanding party will opt to proceed with arbitration on a conditional basis.

The Submission Delegates Authority to Particular Arbitrators to Decide Particular Disputes

In addition to evidencing performance of the pre-dispute arbitration agreement, the submission delegates authority to the arbitrator by requesting her to resolve certain disputes or issues, which she in turn consents to do. The scope of that delegated authority is defined and delimited by the scope of the request; if the parties ask the arbitrator to resolve disputes A and B, the arbitrator is not authorized to decide dispute C, unless the outcome of disputes A and B depends on the outcome of dispute C.

The importance of the submission as the source of a particular arbitrator’s authority to resolve a particular dispute cannot be over emphasized.  Not infrequently, arbitrators, parties and lawyers—and occasionally even some judges—confuse or conflate the scope of disputes parties agree to submit to arbitration with the scope of authority the parties delegate to an arbitrator by their submission.

The scope of disputes that parties agree to submit to arbitration is typically defined very broadly and federal policy in favor of arbitration requires courts to resolve ambiguities in the scope of the arbitration agreement itself in favor of arbitration.  The breadth of a parties’ pre-dispute promise to submit disputes to arbitration is critically important to determine whether one or both of the parties breached that promise.  For example, suppose Parties 1 and 2 have agreed to submit to arbitration a broad range of disputes, including Disputes A, B and C.  Party 1, however, breaches its promise by commencing a lawsuit, which asks the court to decide each of those disputes.  Applicable state or federal arbitration law would enable Party 2 to specifically enforce the arbitration agreement by moving for a stay of litigation and an order compelling Party 1 to submit all three disputes to arbitration and the arbitrator would have the authority to decide them.

Suppose that, instead of commencing an action in breach of its pre-dispute arbitration agreement, Party 1 requests the arbitrator to decide only Dispute A, and that Party 2 does not ask the arbitrator to decide Disputes B and C.  If the arbitrator decides disputes B or C or both, then she exceeds the bounds of her authority.  It doesn’t matter that Party 1 agreed to submit Disputes B and C to arbitration because Party 1 did not breach its promise to submit disputes to arbitration.  Party 1 promised that if it wanted a dispute to be formally adjudicated then it would have to submit it to an arbitrator.  Party 2 made the same promise, and neither party conditioned the other’s right to submit any dispute to arbitration on the other asking the arbitrator to decide all existing arbitrable disputes between the parties.  Had Party 2, in response to Party 1’s arbitration demand, asked the arbitrator to decide Disputes B or C or both, then Party 1 would have had to consent to that submission.  But Party 2 opted not to ask the arbitrator to decide Disputes B and C.  As a result:  (a) neither party breached its agreement to arbitrate; and (b) the arbitrator exceeded her authority by deciding disputes that neither party requested her to decide.

A party defending the resulting award would no doubt stress the broad scope of the arbitration agreement and the federal policy in favor of arbitration, but all that would be beside the point. No matter how broad the scope of the pre-dispute promise to submit disputes to arbitration may have been, it is simply a promise to submit disputes to arbitration, not a delegation of authority to an arbitrator to decide any dispute within the scope of the arbitration agreement in the event one party demanded arbitration of any particular dispute covered by the arbitration agreement. That doesn’t mean that Disputes B or C or both can never be submitted to arbitration; either party is entitled to submit either or both disputes to arbitration by commencing another arbitration proceeding.

Perhaps some might balk at this result and point out that it does not promote “arbitral economy” or even judicial economy, because it may arguably tend to proliferate arbitration and concomitant FAA enforcement litigation. That argument, however, mistakenly assumes, among other things, that arbitration is supposed to promote decision-making economy at the expense of party consent. Were that true, it would undermine arbitration’s consensual nature, which is one of its attractive features.

It is doubtful in any event whether deeming parties to have submitted to arbitration disputes that they did not submit would necessarily promote arbitral or judicial economy.  Had the parties so desired, they could have drafted their pre-dispute arbitration agreement to provide that the submission of any dispute to an arbitrator will empower her to determine any other disputes between the parties related to the submitted dispute and arising out of the same operative nucleus of facts.

But given how deferential a court would be to an arbitrator’s determination of what additional disputes would be deemed to be encompassed within the scope of a submission made under such an agreement, there would be a grave risk that what might otherwise have been a very focused and relatively inexpensive arbitration proceeding could, at the whim of an arbitrator who thought she was doing the right thing, be converted into an exceedingly expensive, multi-phase, multi-hearing, multi-award arbitration proceeding that could drag on for years and spawn numerous FAA-satellite-enforcement proceedings, each of which might entail a separate appeal. That would be the antithesis of arbitral and judicial economy, and, in any event, such long-running, multi-phase arbitration proceedings are already more common than they should be, and occur even though parties typically do not agree to authorize arbitrators to expand the scope of their submissions.

A business person who wants to retain some modicum of control over the dispute resolution process—including control over dispute-resolution time and monetary costs—would be undermining her objectives by entering into such an agreement. It thus comes as no surprise that pre-dispute arbitration agreements generally do not deem a party’s submission of one dispute to be deemed a submission of any other disputes or issues other than those at least arguably subsumed within the scope of the submission.

The Submission Can Expand, as well as Restrict, the Scope of Authority the Parties Contemplated Delegating to an Arbitrator 

The example discussed above demonstrates how the submission can restrict the scope of authority the parties contemplated delegating to an arbitrator, but it can also expand it. It can do both in certain situations, as the following example illustrates.

Suppose Parties 1 and 2 have entered into a broad arbitration agreement under which they agreed to submit to arbitration all disputes arising out of or relating to a contract between them. After a period, disputes between the parties begin to arise, not only out of their contract, but also out of an unrelated contract not containing an arbitration agreement.

Disputes A, B and C relate to the contract containing the arbitration agreement and are within the scope of the arbitration agreement. Disputes D and E relate solely to the other contract and are not subject to arbitration.

Party 1 demands that Party 2 submit Disputes A, B, D and E to arbitration, which Party 1 contends all fall within the scope of the arbitration agreement. Party 2 responds by contending that Disputes B and E are outside the scope of the arbitration agreement, and proceeds to arbitration under a reservation of rights to challenge post-award whether it agreed to arbitrate Disputes B and E.

After briefing and a hearing, the arbitrator makes an award in favor of Party 1 on Disputes A, B and D and in favor of Party 2 on disputes C and E. The parties promptly petition and cross-petition a court for an order confirming the award in part (i.e., entering judgment upon it) and vacating it in part.

Party 1 claims the arbitrator exceeded her authority by deciding Disputes C and E because the parties did not submit Dispute C to arbitration and Party 2 never agreed to submit Dispute E to arbitration. Party 2 claims that Disputes B and D are outside the scope of the arbitration agreement and therefore not subject to arbitration.

How would a court resolve a mess like this? The answer is actually simpler than it might initially appear:

Dispute A is within the Scope of the Arbitrator’s Delegated Authority. Dispute A was within the scope of the arbitration agreement, Party 1 submitted it to arbitration, Party 2 did not object to the submission and, in any event, neither party challenged the arbitrator’s authority to resolve Dispute A.

Dispute B is within the Scope of the Arbitrator’s Delegated Authority. Dispute B was within the scope of the arbitration agreement and Party 1 requested the arbitrator to decide it. While Party 2 objected to its submission, it had previously agreed that such disputes would be submitted to arbitration.

Dispute C is Outside the Scope of the Arbitrator’s Delegated Authority. The parties agreed to submit disputes like Dispute C to arbitration, but neither party requested the arbitrator to decide Dispute C, and accordingly, neither party delegated to the arbitrator the authority to decide that dispute.

Dispute D is within the Scope of the Arbitrator’s Delegated Authority. The parties did not agree to submit disputes like Dispute D to arbitration, but Party 1 requested the arbitrator to decide it, Party 2 manifested its consent to the submission by proceeding to arbitrate it without objection or reservation.

Dispute E is within the Scope of the Arbitrator’s Delegated Authority. The parties did not agree to submit Dispute E to arbitration, but Party 1, the losing party, requested the arbitrator to decide it. Party 2, the prevailing party, objected to the arbitrator’s authority to decide dispute E, but objecting to an arbitrator’s authority does not obligate a party to argue that an award in its favor must be vacated. Party 1 requested the arbitrator to decide the issue, to that extent its request was granted, and Party 2 understandably withdrew its objection when it received a favorable award, and thus ratified the arbitrator’s authority to decide the dispute.

The interplay between the parties’ pre-dispute arbitration agreement and their post-dispute submission is, as our hypothetical demonstrates, determinative of the decision-making authority the parties delegate, or are deemed to have delegated, to the arbitrator. If the only thing that mattered was the parties’ pre-dispute arbitration agreement, then the arbitrator would be deemed authorized to decide Disputes A, B and C, but not Disputes D and E. As it turned out, the only issue the arbitrator was not authorized to decide was Dispute C, and the net result is that the parties, by their submissions, granted the arbitrator authority to decide four of the five disputes rather than only three.

A few other aspects about the interplay between the agreement and the submission warrant mention. First, the submission delimits not only the scope of arbitral authority but also the duration of that authority. Generally, the authority delegated to an arbitrator is deemed exhausted once the arbitrator makes a final award resolving the submitted dispute. Once that happens her authority is generally limited to things not affecting the substance of the award, such as clarifying an ambiguity or correcting a mathematical error, and at some point—which may in certain cases be set by state statute or the parties’ agreement—even that limited authority terminates.

Second, the delegation of authority to an arbitrator to resolve a particular dispute is generally not construed to imply party consent to the arbitrators retaining jurisdiction to hear related disputes that might arise, to monitor compliance with an award or to issue orders concerning the enforcement of the award. The parties presumably may agree otherwise, but ordinarily they do not.

Third, while the parties may by their post-dispute submission empower an arbitrator to decide disputes that are outside the scope of their pre-dispute arbitration agreement, their decision to do so should not be construed to amend the scope of the parties’ pre-dispute arbitration agreement to require the parties to submit to arbitration disputes of the same kind or class that might arise in the future. Once a dispute capable of resolution by arbitration has arisen, parties always have the option of agreeing to submit it to arbitration, even if they never entered into a pre-dispute arbitration agreement. But the decision whether it makes sense to submit an existing dispute to arbitration one is not obligated to submit can turn on any number of considerations pertinent to that particular dispute and the surrounding circumstances. Agreeing to submit voluntarily that dispute to arbitration while retaining the right to decide on a post-dispute basis whether similar, future disputes of the same kind or class should be voluntarily submitted to arbitration is a far less risky proposition than agreeing to expand the scope of a pre-dispute arbitration agreement. Parties who decide to voluntarily submit disputes to arbitration, however, need to be aware of the risk that their counterparts may argue that their voluntary submission demonstrates an intent to broaden the scope of the pre-dispute arbitration agreement, and if necessary, take steps to avoid that risk.

In Part II.B.2 we’ll discuss some other structural aspects of pre-dispute arbitration agreements.

 

Links to Previous Segments of this Multi-Part Small Business B-2-B Arbitration Post:

Part I

Part II.A

Links to Future Segments:

Part II.B.2(A)

Part II.B.2(B)

Part II.B.2(C)

 

 

         

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