June 24, 2009

Parties to a contract often include an arbitration clause based on a belief that arbitration is always cheaper and faster than litigation. That assumption is debatable. What is not up for debate, however, is that a poorly drafted arbitration clause will likely lead to a separate and messy dispute.

In drafting an arbitration clause, clarity is key. The parties should first decide whether they would like a broad or narrow provision. A broad clause typically will cover all disputes arising out of an agreement, while a narrow clause will limit the disputes that may be referred to arbitration. In either case, the court will favor the arbitration clause if a dispute should arise.

The Broad Clause: A Classic Approach

The classic, broad arbitration clause will provide for arbitration of all disputes "arising under or in connection with" a contract. A broad clause will not only encompass contract disputes, but may also include related tort or statutory claims. Oftentimes the arbitrators themselves will be called on to determine if they have jurisdiction over a claim.

Parties entering into multiple agreements to govern an ongoing business relationship must be especially cautious of consistency when including arbitration clauses in their contracts. A recent Illinois case, Casablanca Trax, Inc. v. Trax Record, Inc., is a prime example of how a broad clause in one agreement can lead to prolonged litigation. Casablanca involved a joint venture agreement (JVA) that required the parties to arbitrate "any dispute arising out of" the JVA. The parties also entered into related loan and security agreements containing no such clause. Sure enough, a dispute eventually arose regarding the related agreements, and the parties battled in the Circuit Court of Cook County to decide whether the arbitrator had jurisdiction over the dispute. The Circuit Court held that the JVA arbitration clause did not extend to the related loan and security agreement. However, the Appellate Court later overturned that decision and sent the case back to the arbitrator. So, three years and a lot of wasted time and money later, the parties were back where they began.

The Narrow Clause: Proceed with Caution

A narrow clause only submits certain disputes to arbitration and may exclude some issues from arbitration. As is the case with broad clauses, any dispute over whether a topic falls under the umbrella of arbitration will be decided in favor of arbitrability.

When crafting a narrow arbitration clause, it pays to be wary of over-specificity or over-drafting. Too many layers in an arbitration clause may make it extremely difficult to arbitrate a dispute when one arises. That being the case, narrow clauses should be used sparingly.

The Final Word

In the complex world of arbitration clauses, the bottom line is that both broad and narrow clauses often suffer from drafting errors that could have easily been avoided. Therefore, it is imperative that businesses and individuals work with legal counsel to craft arbitration clauses that are consistent and in harmony with other provisions of their agreements and with related agreements. If not, the very purpose of arbitration will be defeated and the parties may end up in the courtroom after all.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.