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SPECIAL IN-DEPTH FOCUS ON ARBITRATION Business lawyers who write contracts must consider the effects of every provision of the contract, including the "remedies" section. This section determines what happens if a dispute arises between the parties. Some contracts allow for one party to sue for "specific performance", particularly common in real estate contracts, which requires the other party to perform their contractual duties. Other contracts waive the right to jury trials, or eliminate some elements of damages. And many include arbitration provisions. In arbitration, one or more persons (who may or may not be lawyers) hears from each party, decides who is right and wrong, and determines the remedy for the winning party. Recently, several courts have issued opinions on arbitration that show arbitration provisions are much more complex than some may think. Which Disputes Must Be Arbitrated? One of the first issues created by arbitration provisions is what they cover. For example, three people formed Aston Holdings and two of them were parties to a shareholders agreement which included a mandatory arbitration provision. Owner No. 3 claimed that Owners 1 and 2 lied to him about the financial condition and prospects of the company, causing him to sell his 7% ownership to them for $245,000. Two months later, the company was sold for $14 million. Obviously upset at being cut out of making $980,000, Owner 1 sued everybody in sight. Owner 2 tried to get the case thrown out of court, by filing a motion to compel arbitration, even though he was not one of the parties to that agreement. Before the federal Fifth Circuit Court of Appeals, the Court reiterated that it reads arbitration provisions broadly to cover as much as reasonably possible. But it will not generally force non-signatory parties to arbitrate, and this case was no exception, stating: ...the courts must not offer contracts to arbitrate to parties who failed to negotiate them before trouble arrives. To do so frustrates the ability of persons to settle their affairs against a predictable backdrop of legal rules-the cardinal prerequisite to all dispute resolution." Westmoreland v. Sadoux et al., U.S. Court of Appeals for the 5th Circuit, Case No. 01-20793, decided July 18, 2002. Arbitration provisions are typically broad, attempting to cover any dispute related to a particular contract. But in some instances, it may be better to make arbitration discretionary instead of mandatory, and it may be more advantageous to specifically exclude certain matters from arbitration. Typically, the top two advantages to arbitration are (1) you get away from a jury; and (2) the case is decided much more quickly. If you don't need either of these benefits for a particular dispute, consider excluding them from coverage. How Do You Choose the Arbitrator? In 1998, Peak International hired Richard Brook to be its President and CFO. They signed a written contract with an arbitration provision. Within a year, the company was not pleased with the situation, and so it terminated Mr. Brook. Brook and Peak then got into an argument about his severance package, and Brook demanded arbitration. The contract provided that the parties would agree to a particular arbitrator and if no agreement was reached: ..the Employee and the Company shall request the American Arbitration Association to submit a list of nine (9) names of persons who could serve as an arbitrator. The Company and Employee shall alternately remove names from this list "beginning with the party which wins a flip of a coin) until one person remains and this person shall serve as the impartial arbitrator. Selecting one or more arbitrators is important. Some contracts provide that each party may choose one person, with the two arbitrators first selected then choosing a third arbitrator. Agreement by two of the three arbitrators is required. Some contracts provide that each party will choose one person, those two will agree on a third person, and that third person will be the one and only arbitrator. In any even, it is important to spell out how the arbitrator will be selected, and in a way that cannot be disputed or contested by the parties. Usually, the type of dispute likely to end up in arbitration should drive this decision. At a minimum the person should be familiar with the law, if not a retired judge or licensed lawyer. I have been to too many mediations where the mediator was not a lawyer. They are not helpful. The decision maker must know the law well enough to apply it to the dispute. They must also be unbiased, and this is typically the goal of most selection clauses. Brook v. Peak International, Ltd., U. S. Court of Appeals for the 5th Circuit, Case No. 01-50339, decided June 13, 2002. But as illustrated by this next case, while seeking a neutral arbitrator, do not forget to select a competent arbitrator. What Rules must the Arbitrator Use to Decide the Case? Contract lawyers typically include in written contracts which state law applies to the contract, and often even designate the exclusive county in which any court case must be brought. This can be critical when the parties are in different states. We all realize it is important to know the rules one must live by, so we may plan our behavior accordingly. Progressive Data Systems, a software and computer company, got into a dispute with Jefferson Randolf Corp., a former customer trucking company, over a written contract that included a mandatory arbitration provision. After a 2 day hearing in July of 2000, arbitrator Henry M. Abelman ruled for Progressive Data and awarded damages of $81,540 plus attorneys fees, administrative fees and expenses. Jefferson Randolf sued in Georgia state court to set aside the award, believing the arbitrator mis-applied the law. The trial court agreed, calling it a "manifest disregard of the law", and set aside the arbitration award. But on appeal the Georgia Supremes said that Georgia law allowed arbitration awards to be set aside for only four reasons: (1) the arbitrator was corrupt, (2) the arbitrator was partial toward one side of the case, (3) the arbitrator overstepped his authority, or (4) the arbitrator failed to follow procedure set by Georgia law. Since "manifest disregard of the law" was not on that list, an arbitration decision that was not legally correct could not be set aside. The Georgia Supremes did note that federal courts typically do consider setting aside arbitration awards which disregard the law, so the moral of this story is, if you need to set challenge an arbitrator's award for this reason, make a federal case out of it just to be on the safe side. Progressive Data Systems v. Jefferson Randolph Corp., Case No. S01G1765, (Ga. Supreme Court, decided July 15, 2002). Could this happen in Texas? The Texas arbitration rules are found in Chapter 171 of the Civil Practice and Remedies Code, and they allow Texas courts to set aside arbitration awards for any of the following reasons:
Texas cases use all different sorts of language to describe how "final" a final arbitration award is. Some courts have held arbitration awards are not appealable unless somehow "impeached," leaving open the possibility that an arbitration award that resulted from an arbitrator mistakenly applying the law, would be set aside. On the other hand, another case says that unless the arbitration agreement specifically reserves the right to appeal the arbitration award, the award is final, period. Yet another says that arbitration awards may be set aside for a gross mistake as would imply bad faith or failure to exercise an honest judgment, whereas a "mere" mistake of fact or law alone is insufficient to set aside an award. Confused yet? I think the fact that lawyers have to deal with such seemingly contradictory holdings is why it is called the "practice" of law. Of course, the better course of action is to specifically state, in the arbitration provision, the grounds for setting aside the award by a court. And a big consideration on this issue is how much the parties want to use arbitration to contain costs. The more rights of appeal and grounds to set aside the award, the more expensive the process becomes, and the more time it takes to achieve certainty in the result. But taking a broader view of the Texas case law to date, it seems that most Texas courts view arbitrators as similar to trial court judges, which means that the award can be appealed and set aside for some legal defect, while the reviewing court cannot change the award just because it would have decided the case differently. Courts must be very deferential to the arbitrator's decision and give them a wide latitude of discretion. Interestingly, this particular reason to overturn an arbitration award was not written by the legislature, but by the judges. Even more interesting, if a Texas court read the Texas arbitration act as strictly as did the Georgia Supremes, I think the result would be the same. Can Arbitration Limit the Remedies Legally Available--and Even Required? Most if not all of us are familiar with the retail beauty store "Glamour Shots®". Glamour Shots Licensing, Inc., owns the trademark "Glamour Shots" and is the franchisor. It is affiliated with "Candid Color Systems, Inc." which provides its franchisees with photo processing needs related to the operation of Glamour Shots franchises. In 2000, one of its franchisees, Investment Partners, L.P., sued Glamour Shots Licensing, Inc., and Candid Color Systems, Inc., for federal antitrust violations. Investment Partners asserted that the amounts charged by Candid Color Systems were exorbitant as compared to other competitors for photo finishing services. Investment Partners believed the requirement to use Candid Color Systems illegally "tied" the photo processing services to the other franchise services provided along with the name. The Defendants quickly filed a motion to force arbitration. The court had no trouble compelling arbitration, and then dealt with the more thorny issue of damages. The arbitration clause stated "The arbitrators shall not award punitive damages." Simple, perhaps even elegant. But Investment Partners wanted punitive damages in this case. Federal antitrust law, in fact, requires the judge to triple the dollar amount of any judgment if it finds an antitrust violation. Investment Partners asked the court to write that sentence out of the arbitration provisions, on the basis that public policy prevents the waiver of that remedy in this type of case. They argued that treble damages were a statutorily guaranteed right. And there were several cases which directly held exactly that. They also argued that "statutory treble damages" were compensatory damages, not punitive damages. Of course, Glamour Shots Licensing wasn't impressed with the argument. "A deal's a deal" they argued. And certainly treble damages were meant to be punishment, thereby making them punitive. The Court totally sidestepped the "void as a matter of public policy" argument and instead simply decided that the parties meant "punitive damages" to mean punitive damages as are "awarded under notoriously open-ended legal standards and a broadly defined constitutional limit concerning the amount awarded." Treble damages, the Court decided, were "a mere mathematical expansion of the actual damages calculated by the arbitrator." And so, Investment Partners got the ability to receive treble damages from the arbitrator. I sense a settlement coming on. Top 5 Considerations in Implementing an Arbitration Policy As illustrated by these cases, when deciding whether to agree to an arbitration provision, here are the Top 5 concerns to remember:
As you can see, writing the best possible arbitration provision requires a lot of "what if" thinking as you contemplate every reasonably conceivable way it could be applied. Close
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