Arbitration clause
Encyclopedia
An arbitration clause is a commonly used clause in a contract
that requires the parties to resolve their disputes through an arbitration
process. Although such a clause may or may not specify that arbitration occur within a specific jurisdiction
, it always binds the parties to a type of resolution outside of the court
s, and is therefore considered a kind of forum selection clause
.
In the United States
, the federal government has expressed a policy of support of arbitration clauses, because they reduce the burden on court systems to resolve disputes. This support is found in the Federal Arbitration Act
, which permits compulsory and binding arbitration, under which parties give up the right to appeal an arbitrator's decision to a court. In Prima Paint Corp. v. Flood & Conklin Mfg. Co.
, the U.S. Supreme Court established the "separability principle", under which enforceability of a contract must be challenged in arbitration before any court action, unless the arbitration clause itself has been challenged.
Furthermore, arbitration clauses are often combined with geographic forum selection clauses, and choice-of-law clauses, both of which are also fully enforceable. The result is that a plaintiff may find himself or herself compelled to arbitrate in a strange private forum thousands of miles from home, and the arbitrators may decide the case on the basis of the law of a state or a nation which the plaintiff has never visited.
An arbitration clause may nevertheless be challenged and held invalid if it designates a biased party as the arbitrator. In Graham v. Scissor-Tail, Inc, 623 P.2d 165 (Cal. 1981), for example the Supreme Court of California
found that an arbitration clause in a contract of adhesion which necessarily puts disputes before a body that would tend to be biased towards the defendant, is unduly oppressive, and therefore void as unconscionable
. For this reason, many arbitration clauses designate widely recognized neutral organizations such as the American Arbitration Association
.
Other terms may void an arbitration clause. In Armendariz v. Foundation Health Psychcare Services, Inc.
, 24 Cal 4th 83 (2000), a California
appellate court held that a one-sided arbitration clause in a contract of adhesion for employment (deemed a necessity) may also be voided as unconscionable because of the relative positions of the parties involved. In that case, the court found there to be procedural unconscionability where an employee was held to arbitration but the employer was not (in other words, the agreement lacks mutuality of obligation, although, in Federal Court, the United States Court of Appeals for the Eighth Circuit
has ruled the exact opposite on mutuality of obligation), and substantive unconscionability where the contract limited the damages the employee could recover through arbitration.
Some legal orders exclude or restrict the possibility of arbitration for reasons of the protection of weaker members of the public, e.g. consumers. E.g., German law excludes disputes over the rental of living space from any form of arbitration, while arbitration agreements with consumers are only considered valid if they are signed, and if the signed document does not bear any other content than the arbitration agreement. The restriction does not apply to notarized agreements, as it is presumed that the notary public will have well informed the consumer about the content and its implications.
The courts have also upheld clauses which specify resolution of disputes other than in accordance with a specific legal system. These include provision indicating:
bodies provide sample arbitration clauses for parties to use. Examples of these are:
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
that requires the parties to resolve their disputes through an arbitration
Arbitration
Arbitration, a form of alternative dispute resolution , is a legal technique for the resolution of disputes outside the courts, where the parties to a dispute refer it to one or more persons , by whose decision they agree to be bound...
process. Although such a clause may or may not specify that arbitration occur within a specific jurisdiction
Jurisdiction
Jurisdiction is the practical authority granted to a formally constituted legal body or to a political leader to deal with and make pronouncements on legal matters and, by implication, to administer justice within a defined area of responsibility...
, it always binds the parties to a type of resolution outside of the court
Court
A court is a form of tribunal, often a governmental institution, with the authority to adjudicate legal disputes between parties and carry out the administration of justice in civil, criminal, and administrative matters in accordance with the rule of law...
s, and is therefore considered a kind of forum selection clause
Forum selection clause
A forum selection clause in a contract with a conflict of laws element allows the parties to agree that any litigation resulting from that contract will be initiated in a specific forum...
.
In the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, the federal government has expressed a policy of support of arbitration clauses, because they reduce the burden on court systems to resolve disputes. This support is found in the Federal Arbitration Act
Federal Arbitration Act
In United States law, the Federal Arbitration Act is a statute that provides for judicial facilitation of private dispute resolution through arbitration. It applies in both state courts and federal courts, as was held in Southland Corp. v. Keating...
, which permits compulsory and binding arbitration, under which parties give up the right to appeal an arbitrator's decision to a court. In Prima Paint Corp. v. Flood & Conklin Mfg. Co.
Prima Paint Corp. v. Flood & Conklin Mfg. Co.
Prima Paint Corp. v. Flood & Conklin Mfg. Co. , is a United States Supreme Court decision that established what has become known as the "separability principle" in contracts with arbitration clauses...
, the U.S. Supreme Court established the "separability principle", under which enforceability of a contract must be challenged in arbitration before any court action, unless the arbitration clause itself has been challenged.
Furthermore, arbitration clauses are often combined with geographic forum selection clauses, and choice-of-law clauses, both of which are also fully enforceable. The result is that a plaintiff may find himself or herself compelled to arbitrate in a strange private forum thousands of miles from home, and the arbitrators may decide the case on the basis of the law of a state or a nation which the plaintiff has never visited.
An arbitration clause may nevertheless be challenged and held invalid if it designates a biased party as the arbitrator. In Graham v. Scissor-Tail, Inc, 623 P.2d 165 (Cal. 1981), for example the Supreme Court of California
Supreme Court of California
The Supreme Court of California is the highest state court in California. It is headquartered in San Francisco and regularly holds sessions in Los Angeles and Sacramento. Its decisions are binding on all other California state courts.-Composition:...
found that an arbitration clause in a contract of adhesion which necessarily puts disputes before a body that would tend to be biased towards the defendant, is unduly oppressive, and therefore void as unconscionable
Unconscionability
Unconscionability is a term used in contract law to describe a defense against the enforcement of a contract based on the presence of terms that are excessively unfair to one party...
. For this reason, many arbitration clauses designate widely recognized neutral organizations such as the American Arbitration Association
American Arbitration Association
The American Arbitration Association is a private enterprise in the business of arbitration, and one of several arbitration organizations that administers arbitration proceedings. The AAA also administers mediation and other forms of alternative dispute resolution. It is headquartered in New York...
.
Other terms may void an arbitration clause. In Armendariz v. Foundation Health Psychcare Services, Inc.
Armendariz v. Foundation Health Psychcare Services, Inc.
Armendariz v. Foundation Health Psychcare Services, Inc., 24 Cal. 4th 83 , was a case decided by the Supreme Court of California that defined the California standard for unconscionability. The court required that there be both a procedural and substantive element of unconscionability for a...
, 24 Cal 4th 83 (2000), a California
California
California is a state located on the West Coast of the United States. It is by far the most populous U.S. state, and the third-largest by land area...
appellate court held that a one-sided arbitration clause in a contract of adhesion for employment (deemed a necessity) may also be voided as unconscionable because of the relative positions of the parties involved. In that case, the court found there to be procedural unconscionability where an employee was held to arbitration but the employer was not (in other words, the agreement lacks mutuality of obligation, although, in Federal Court, the United States Court of Appeals for the Eighth Circuit
United States Court of Appeals for the Eighth Circuit
The United States Court of Appeals for the Eighth Circuit is a federal court with appellate jurisdiction over the district courts in the following districts:* Eastern District of Arkansas* Western District of Arkansas...
has ruled the exact opposite on mutuality of obligation), and substantive unconscionability where the contract limited the damages the employee could recover through arbitration.
Some legal orders exclude or restrict the possibility of arbitration for reasons of the protection of weaker members of the public, e.g. consumers. E.g., German law excludes disputes over the rental of living space from any form of arbitration, while arbitration agreements with consumers are only considered valid if they are signed, and if the signed document does not bear any other content than the arbitration agreement. The restriction does not apply to notarized agreements, as it is presumed that the notary public will have well informed the consumer about the content and its implications.
Informal clauses
In keeping with the informality of the arbitration process, the law is generally keen to uphold the validity of arbitration clauses even when they lack the normal formal language associated with legal contracts. Clauses which have been upheld include:- "arbitration in London - English law to apply"
- "suitable arbitration clause"
- "arbitration, if any, by ICC Rules in London"
The courts have also upheld clauses which specify resolution of disputes other than in accordance with a specific legal system. These include provision indicating:
- that the arbitrators "must not necessarily judge according to the strict law but as a general rule ought chiefly to consider the principles of practical business"
- "internationally accepted principles of law governing contractual relations"
Sample clauses
A number of international arbitrationInternational arbitration
International arbitration is a leading method for resolving disputes arising from international commercial agreements and other international relationships...
bodies provide sample arbitration clauses for parties to use. Examples of these are:
- The Chartered Institute of ArbitratorsChartered Institute of ArbitratorsThe Chartered Institute of Arbitrators is a London based membership organisation for arbitrators for the promotion and facilitation of dispute resolution...
:
-
- "Any dispute or difference arising out of or in connection with this contract shall be determined by the appointment of a single arbitrator to be agreed between the parties, or failing agreement within fourteen days, after either party has given to the other a written request to concur in the appointment of an arbitrator, by an arbitrator to be appointed by the President or a Vice President of the Chartered Institute of Arbitrators."
- The London Court of International ArbitrationLondon Court of International ArbitrationThe London Court of International Arbitration is an institution based in London, United Kingdom providing the service of international arbitration....
:http://www.lcia-arbitration.com/
-
- "Any dispute arising out of or in connection with this contract, including any question regarding its existence, validity or termination, shall be referred to and finally resolved by arbitration under the LCIA Rules, which Rules are deemed to be incorporated by reference into this clause.
-
- The number of arbitrators shall be [one/three].
-
- The seat, or legal place, of arbitration shall be [insert city or country].
-
- The language to be used in the arbitral proceedings shall be [insert language].
-
- The governing law of the contractContractA contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
shall be the substantive law of [insert governing law]."
- The governing law of the contract
- The International Court of ArbitrationInternational Court of ArbitrationThe International Court of Arbitration is an institution for the resolution of international commercial disputes. The International Court of Arbitration is part of the International Chamber of Commerce....
:http://www.iccwbo.org/court/english/arbitration/model_clause.asp
-
- "All disputes arising out of or in connection with the present contract shall be finally settled under the Rules of Arbitration of the International Chamber of CommerceInternational Chamber of CommerceThe International Chamber of Commerce is the largest, most representative business organization in the world. Its hundreds of thousands of member companies in over 130 countries have interests spanning every sector of private enterprise....
by one or more arbitrators appointed in accordance with the said Rules."
- "All disputes arising out of or in connection with the present contract shall be finally settled under the Rules of Arbitration of the International Chamber of Commerce
- The American Arbitration AssociationAmerican Arbitration AssociationThe American Arbitration Association is a private enterprise in the business of arbitration, and one of several arbitration organizations that administers arbitration proceedings. The AAA also administers mediation and other forms of alternative dispute resolution. It is headquartered in New York...
also provides a wide sample of bespokeBespokeBespoke is a term employed in a variety of applications to mean an item custom-made to the buyer's specification...
arbitration clauses on its website.http://www.aaauonline.org/referenceCenter.aspx?cid=1