A Guide to Drafting an Arbitration Agreement

What is an Arbitration Agreement?

An arbitration agreement is an alternative dispute resolution (ADR) contract made between parties to a dispute or potential dispute. An arbitrator makes decisions which may be enforced by a court, and the arbitration process is also held in a manner similar to a trial but without juries. The process is one reserved for parties to a contract, but it also provides parties with a method of litigation, without essential procedural rules being applied. Arbitration usually occurs because one or both parties signed a contract which contains an arbitration clause. When that is the case, the case will be tried in an arbitration tribunal, not a court. The purpose of an arbitration agreement is to be binding on the parties that create it .
Arbitration is a process where the parties to the dispute agree or are compelled to submit the dispute to a neutral third party for a decision to be made. Like a trial, it is often a phased process, and an award is issued at the end of the process. Arbitration is an efficient use of time and money. It is not held in a courtroom, but in an arbitrator’s office, and is held like a trial, sans a jury. It is overseen by an arbitrator who listens to the proof and makes a decision, and sometimes issues sanctions for violations. It is a process governed by the Federal Arbitration Act as amended, but it does not take place in an evaluative manner.

Components of Arbitration Agreement Draft

The drafting of an arbitration agreement is an important process, and the goal of the drafter should be to produce an enforceable arbitration agreement that achieves their client’s goals as closely as possible. The drafter should, therefore, consider addressing some or all of the following issues:
Scope of the Arbitration Agreement
A well-drafted arbitration agreement should specify which disputes are to be arbitrated. For instance, the scope could be limited to any dispute arising under the contract, or it could be a broad provision requiring any disputes between the parties to be arbitrated. Depending on the context, there could also be a carve-out for certain claims such as equitable claims or a request for injunctive relief. The drafter should clarify that both existing and future disputes are covered by the arbitration clause.
To illustrate the importance of the justification for the dispute being arbitrated, assume a commercial leasing agreement contains a reasonable and clear arbitration provision requiring that all disputes concerning the lease agreement are to be arbitrated. Given this broad language, the drafter would be able to reasonably predict that the arbitration clause would be enforced by a Court in enforcing the parties’ arbitration agreement. Now, assume instead that the arbitration provision stated that any dispute "relating to" the lease agreement has to be arbitrated. "Relating to" is a broad trigger for coverage under the arbitration agreement and can easily be interpreted to cover all disputes. While a Court may interpret the problematic language as covering all disputes, an arbitrator is less likely to do so. Why? Because courts generally agree to defer broad discretion to an arbitrator interpreting the terms of an agreement. In this instance, an arbitrator could theoretically reach the opposite conclusion due to the same contractual language.
Arbitration Rules
A client engaging in litigation may understand the rules of civil procedure and the court system that apply to them. However, clients usually have no familiarity with the applicable rules and regulations for an arbitration. The drafter therefore needs to explain how the arbitration system works to the client. In general, an arbitration agreement should specify what arbitration rules govern the proceedings. These rules can be from a local or private arbitration association, or those established by the American Arbitration Association ("AAA"), JAMS (formerly known as the Judicial Arbitration and Mediation Services), or any other group that arbitrates contractual disputes. If the drafter uses a type of arbitration rule, then the drafter should ensure that the record of the case reflects what rules were used.
Selection of Arbitrators
The drafter should clearly spell out how the parties will select the arbitrators. This will again depend on the applicable arbitration rules and the nature of the agreement itself. For instance, if the arbitration involves a sophisticated corporate agreement targeting financial institutions, the parties may wish to have a panel of three arbitrators with knowledge in that field and have each party select one arbitrator to serve on the panel. If the agreement targets a more pedestrian product sale, then the parties may reasonably select an arbitrator who is a former judge; or they may choose to have a panel of three arbitrators. In any event, the drafter should specify clearly who gets to name the arbitrator(s).
Governing Law
Similar to any other contract, the parties to an arbitration agreement may select the law to be applied in connection with the agreement. For example, if the arbitration should be governed by Illinois law instead of any other relevant state law, then the drafter should expressly specify that Illinois law should apply. On the other hand, under the Federal Arbitration Act ("FAA"), this provision may be deemed unnecessary since Chapters One, Two, Three and Five of the FAA will apply to arbitration as long as the transaction involves commerce. 9 U.S.C. §§ 1 – 3.

Advantages of Arbitration Agreement

The benefits of using an arbitration agreement include the following: (1) confidentiality, as arbitration proceedings are private, (2) speed and flexibility, as parties are permitted to tailor arbitration procedures to their specific needs, and (3) economy, as parties may avoid the formalities of court and even have arbitration proceedings be conducted in a business-like manner (i.e., at the parties’ offices) pursuant to ad hoc contract terms agreed to by all such parties.
For these reasons, arbitration agreements can be beneficial, provided that they are drafted properly.

Common Mistakes with Arbitration Agreements

Drafting an arbitration agreement may seem simple—the words of the agreement are defined clearly within the dispute resolution section of a contract. However, there are often nuanced issues that arise or that are completely overlooked. Below are some typical mistakes which may prevent an arbitration agreement from being enforceable or may cause disputes as to the scope of the arbitration provision.
The most obvious and damaging pitfall would be failing to include arbitration language in the contract altogether. Arbitration provisions should be clear and included as a distinct article in the contract. Often, a dispute arises where the parties disagree as to whether there is an arbitration clause or the scope of the arbitration clause. In order to avoid the potential costs of "removing" or "staying" any litigations, these kinds of provisions must be clearly articulated.
The next most common pitfall is unclear language or contradictions within the contract as a whole. An example of this can be found in Hackett v. California Mutual Insurance Company, 2010 WL 2643484 (N.J. App. Div.) (holding that defendant waived its right to compel arbitration because the complaint was filed after the defendant had made a demand for arbitration). In Hackett, the defendant and plaintiff entered into an insurance contract. The insurance policy included a provision requiring the parties to arbitrate any dispute under the policy. Subsequently, plaintiff filed a complaint in New Jersey state court for breach of contract and in response, the defendant filed an answer requesting that the court compel arbitration. Plaintiff countered that because defendants demanded arbitration subsequent to plaintiff seeking remedies in the trial court , defendant waived the right to compel arbitration. The court agreed, stating that the defendant’s answer, including the demand for arbitration and named a New Jersey attorney to represent them was sufficient to perfect the waiver.
A surrounding issue can also create problems: for instance, if a Notice of Intent to Arbitrate is required, but not followed per the terms of the arbitration provision. In Sarvis v. State Farm Mutual Automobile Insurance Company, 2007 WL 1526199 (Va.App.), Sarvis was injured in an auto accident. The tortfeasor was insured with State Farm and it was underinsured beyond his own coverage. The policy required Sarvis to file a written request for arbitration against State Farm within two years of the accident owing to a statute of limitations. Sarvis filed a claim with State Farm and then a Notice of Intent to Arbitrate form. Sarvis then sent further Notices of Intent to Arbitrate as the parties could not agree on the amount owed. State Farm attempted to present a third offer prior to the expiration of the statute of limitations. The panel ruled in favor of Sarvis for the amount sought to resolve the claim. State Farm appealed arguing that Sarvis failed to comply with the requirement from the Policy that he provide notice of intent "before proceeding to arbitration" because Sarvis failed to confirm his acceptance of the last offer of compromise. The trial court affirmed and the appellate court then affirmed holding that Sarvis complied.
Finally, costs can be an issue. For instance, most provisions will require equal sharing of the costs to arbitrate the claim, including fees and expenses. However, the Supplemental Rules for the Resolution of Large Complex Commercial Disputes require the parties to advance all costs and expenses of arbitration.

Enforceability of Arbitration Agreement

In modern practice, international arbitration agreements are usually favored as a way to make certain that future disputes are subject to the arbitral regime as opposed to the court system. It would be patently unfair to argue that simply because an arbitrator may make an error in law or in fact, a party should lose their right to arbitration.
With a proper arbitration agreement, a party may even be able to select where and by whom the adjudication will take place. And not in the local court where the parties have not chosen, and the judiciary may not be aware of problems such as corruption, bribery, or threats. The parties may even select a close-by third party jurisdiction to administer the adjudication, and thereby avoid the difficulties of facilities, accommodation, distance, communication, and language.
The issue is that if an arbitration clause is to be enforceable, it must be effective and interpreted correctly and consistently with local law. In short, there are laws in each jurisdiction concerning the validity of an arbitration agreement, especially as to whether an invalid clause renders the whole contract void and unenforceable.
Recent case law provides an excellent start for the arbitration practitioner to start to formulate the agreement that will fit their needs while making sure it is enforceable. The principles of arbitrability were even adopted into law, and serve as a basis for the validity of arbitration agreements in the UAE.
In order to determine if the agreement is valid, one can research various statutes and international conventions. One of the most important conventions is the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. A second important convention is the European Convention on International Commercial Arbitration, which seeks to consolidate provisions of various national laws of Contracting States. A third important convention is the Lebanon Convention on the Execution of Foreign Arbitral Awards.

Examples of Effective Arbitration Agreements

To provide an illustrative "light" touch, I have included references to three arbitration agreements that have been drafted in exemplary manner. The first of these agreements is one used by the construction industry (and is referred to as the "CEA", for "Construction Employers’ Association"). This is the most widely used agreement in the Chicago area for building construction, and it provides for the arbitration of disputes between the signatory parties and their subcontractors over matters arising under the CEA (which agreement is available on-line at the CEA website). The employment relationship among the parties to its arbitration agreement is one of the subjects covered by the CEA.
The next arbitration agreement is known as the Joint Arbitration Agreement for Subcontract Weak Loss Restoration Payments. This agreement is used by some of the largest contractors and owners in Chicago for the arbitration of subcontractor claims for the replacement of property damaged by insured casualty loss. This agreement was drafted by a committee that included representatives of the American Arbitration Association as well as experienced lawyers , construction company employees and subcontractors. A copy of this agreement is available on-line at the website of the lead contractor on the project for which the agreement was adopted, the Turner Construction Company.
The third arbitration agreement is used by the Open Systems Pipeline Contractor’s Association, and it consists of various model contracts and subcontracts published by the Association pursuant to which the Association’s collectively-bargained labor agreements provide for the arbitration of disputes among its participants. The most current version of this model agreement, and copies of earlier editions dating back to 1993, is available on-line on the Groffnet.com website.
With respect to the construction industry in Chicago, the Joint Arbitration Agreement for Subcontract Weak Loss Restoration Payments and the CEA arbitration agreement (to which it is cross-referenced in some cases) are the "gold standard" among my clients who need to resolve complex disputes without the use of courts or resort to popular arbitration rules. The third arbitration agreement cited above consists of standard form construction contracts, subcontracts, statements of work and general conditions that incorporate an arbitration agreement that has been drafted in a comprehensive and thoughtful manner.