Be careful how you draft your arbitration clause. You may get more, or less, than you bargained for.

Many people believe that an arbitration clause guarantees them all the touted benefits of arbitration—reduced costs, streamlined proceedings, confidentiality and certainty of forum. But, the mere existence of an arbitration clause is not enough, for a poorly drafted or incomplete one can actually do more harm than good.

For example, what happens when one party claims a particular dispute is beyond the scope of the arbitration clause? Who makes that initial determination? An arbitrator? A judge?

It turns out the answer depends on what law applies. Under the Illinois Uniform Arbitration Act (IUAA), courts generally have the initial responsibility to determine whether the parties agreed to arbitrate a particular type of dispute. See Equistar Chemicals, LP v. Hartford Steam Boiler Inspection and Ins. Co. of Connecticut, 883 N.E.2d 740, 745 (Ill. App. 4th Dist. 2008). If it is clear that the dispute falls within the scope of the arbitration clause, the court will compel arbitration. If it is clear that the dispute falls outside the scope of the provision, the court will rule against arbitration and hear the case. If, however, it is unclear whether the dispute is subject to arbitration, it becomes a question of contract interpretation—which then reverts back to the arbitrator.

Even then, however, the courts are not precluded from later considering whether the arbitrators exceeded their jurisdiction. This means an award can be vacated after
the parties have expended all the time and expense of arbitration, based on a posthearing finding that the arbitrator lacked jurisdiction after all.

Does this save you any time or money?

In contrast to the IUAA, the Federal Arbitration Act (FAA) has been interpreted to mean that where parties agree to arbitrate “all disputes arising under the contract,”
then the arbitrator, and not the court, shall determine whether a particular dispute is arbitrable—unless one of the parties challenges the arbitration clause itself, e.g.,
claims it was induced by fraud. In that case, a court will determine arbitrability.

But, how do we know whether the IUAA or the FAA applies? If the contract involves interstate commerce, federal law preempts state statutes and the FAA applies. If not, or if the clause provides that the arbitration will be conducted in accordance with state law, the FAA does not apply even if interstate commerce is involved. See Tortoriello v. Gerald Nissan of North Aurora, Inc., 882 N.E. 2d 157 (Ill. App. 2d Dist, 2008).

Simple enough, right?

By the way, what does it mean to challenge the “scope” of the arbitration provision? If the parties have agreed to arbitrate, don’t they have to arbitrate everything?
Maybe not. If the arbitration clause applies to “all claims arising under the contract,” and one party claims the contract was induced by fraud, there may be no contract and thus no agreement to arbitrate.

And who decides whether the contract was induced by fraud? The arbitrator? The court? Some combination of both? Law professors may enjoy exploring the differences
between state and federal law, and between the laws of different states on these issues. Parties to litigation will not.

What if you want emergency relief? You want a TRO to stop your opponent from continuing to use the brand name they sold you along with their $100 million manufacturing business. Now you must go to court, right? Not if you have agreed to apply the Commercial Rules of the American Arbitration Association (AAA). They provide for interim relief. This author once got a complaint and request for TRO dismissed by a federal court because the contract contained an arbitration clause adopting the AAA rules and the opponent had failed to seek interim relief as provided for therein. Who knew?

If all this doesn’t give you enough to think about, what about the procedures that will apply once the jurisdiction of the arbitrator is established? How many arbitrators will
hear the case? If more than one, will they all be neutral or will there be two party-appointed arbitrators and one neutral to break ties? (I recommend against this format.) Will the parties be able to conduct depositions? Serve written discovery? If the award is erroneous, is there an opportunity for appeal? It’s all too complicated. Arbitration raises more problems than it solves. We should just stick with the courts, right? Not necessarily. Let’s get back to basics. Think back to Contracts 101.

Nearly all of the foregoing concerns can be addressed by careful drafting. With narrow exceptions, courts will uphold the parties’ agreement as to what types of disputes
are subject to arbitration, what law will apply, whether emergency relief can be obtained in arbitration and what procedures will govern. Parties can state in their agreement how many arbitrators will hear the case, whether written and oral discovery will be allowed, whether post-hearing motions may be made and so on. They can even provide for an appeal. Include a provision which allows for review of the initial decision by a panel of three different arbitrators and specify the scope of their review.

You may start to lose some of the cost savings that come with a non-appealable decision, but you can still reap many of the benefits of arbitration, such as confidentiality
and a generally speedier process—and you can preserve much of the cost savings through streamlined discovery and pre-hearing procedures. You can even include a provision that shifts the cost of the appeal to the losing party. Too harsh? Include a provision that shifts only part of the cost. The permutations are practically endless.

So, what is the lesson? An arbitration clause, like any other part of a contract, must be properly drafted. Indeed, you can end up litigating a case within a case if your
arbitration clause is unclear with respect to its scope, the question of who determines that scope, and the applicable law and procedures. The savings you had hoped to
obtain through arbitration will quickly evaporate (and then some).

But with foresight, careful drafting and a dash of creativity, you will find that agreements to arbitrate can bring enormous benefits. Endeavor to remove uncertainty with
your pen (or word processor) at the front end of the process; don’t leave uncertainties to be resolved by a court or arbitrator, or worse yet—by some expensive combination of both.

Case Highlights

A team of Katten’s Chicago-based litigation attorneys including Breanne Dunn, Sonja Clayton-Pedersen, Tim Patenode and James Hutchison recently obtained summary judgment in favor of a real estate developer client, a subsidiary of the New York-based Related Companies. The case was filed in 2006 by a Chicago high-rise condominium association and involved construction related claims. The evidence garnered by the Katten team, together with arguments concerning the state of Illinois jurisprudence, persuaded the judge that our client was entitled to judgment as a matter of law.