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Good enough for Goldilocks

Finding an arbitration clause that fits just right

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You remember the infamous Goldilocks, always searching for the perfect fit while she ate the three bears' porridge, sat in their chairs and slept in their beds. You don't have to jump through quite as many hoops to draft an arbitration clause that fits your needs perfectly, but some trying on for size should be routine in every deal.

O'Connell and Evendorff

Too hot, too cold or just right? Ten issues to consider:

1) Organization

Several arbitration organizations are willing to settle differences for a fee. U.S.-based companies often use Judicial Arbitration and Mediation Services (JAMS), the International Chamber of Commerce (ICC), the United Nations Commission on International Trade Law (UNCITRAL) and the American Arbitration Association (AAA). Be aware that some organizations have multiple sets of rules; for instance, the AAA has different international arbitration rules and commercial arbitration rules. Of course, you can always modify a specific organization's rules in your clause, or draft your own rules entirely.

2) Scope

What is your arbitration clause intended to cover: the missing porridge, the broken chair or everything? Arbitration clauses can be written to cover only breach or interpretation of contract issues, or to cover all disputes relating to an agreement. Be specific about which claims you intend the clause to cover when drafting your clause, because any ambiguities favor arbitration.

3) Filing fees

Filing fees vary widely between arbitration organizations. For example, in order to set in motion an arbitration with a $1 million amount in controversy, the ICC requires an advance payment of $2,500, the AAA International Arbitration Rules require filing and case service fees of $8,500 and JAMS requires a payment of only $300. As your arbitration progresses, additional costs are incurred. How's the temperature of that porridge?

4) Number of arbitrators

One bear is certainly cheaper than three, but if your bear becomes grizzly, you may want someone else around to temper her decision. When the parties have not agreed upon the number of arbitrators, the ICC, JAMS and the AAA international arbitration rules are likely to appoint just one person. However, UNCITRAL will appoint three arbitrators, and if the claim or counterclaim involves at least $1 million then the AAA commercial arbitration rules provide for three arbitrators as well.

5) Selection of arbitrators

If it would be beneficial for your arbitrators to have specific language skills or familiarity with your industry, then require these characteristics in your arbitration clause. Consider that each organization has a different method of choosing the arbitrators as well; for example, when there are to be three arbitrators, UNCITRAL rules specify that each party may appoint an arbitrator, and those two arbitrators then choose the third. UNCITRAL, AAA commercial arbitration rules and JAMS will send a list of potential arbitrators to each party and, if the parties are unable to agree on an arbitrator, each may strike objectionable names from the list and rank the remaining names according to their preference. The most preferable person according to both parties will then be chosen, or if no agreement is reached, then the organization will select the arbitrator.

6) Location of arbitration

Goldilocks simply walked through the forest, but your arbitration may take you across several continents. Although the importance of travel costs is obvious, the real issue to consider may be your host country's procedural rules. Specify the place of arbitration and the governing law in your arbitration clause, keeping in mind that when you win your arbitration, you will still need to collect your award.

7) Discovery

Just as Goldilocks was lured into the bears' home by the scent of porridge, people are drawn to arbitration by the belief that the process is quicker and easier due to a lack of discovery. But is that true? The amount of discovery permitted can vary widely between organizations, and even within the same organization. For instance, expect more discovery under the AAA commercial arbitration rules than under the AAA international arbitration rules. Consider specifying the type and amount of discovery to be permitted within your arbitration clause.

8) Punitive damages

Did Goldilocks know that the baby bear's chair would break before she sat on it? Expressly state in your arbitration clause that punitive damages are to be permitted if you think you will want them. Of course, many commercial parties would prefer to have punitive damages unavailable to both sides, and the AAA's international arbitration rules do not allow any party to collect punitive, exemplary or similar damages without such a specific clause permitting punitive damages.

9) Fees and costs

Most arbitration rules allow attorneys fees and costs to be awarded at the discretion of the arbitrator. UNCITRAL rules state that the unsuccessful party will bear the costs of arbitration, while the AAA commercial arbitration rules state that expenses, such as the arbitrator's travel costs, shall be split evenly between the parties unless the arbitrator decides otherwise.

10) Appeals

Can you appeal the decision of the arbitrator if you lose? Probably not. The Federal Arbitration Act states that an arbitration award may be vacated if procured by corruption, fraud, undue means or where the arbitrators are guilty of misconduct or exceeded their powers. This is true even if the arbitrators clearly misinterpreted the law or misunderstood the facts. The circuit courts are split on whether your arbitration clause may permit an appeal despite the statute, so you may want to include appeal rights in your clause and hope for the best.

Then she jumped out the window and ran all the way home...

Goldilocks made it home safely after her scare with the bears, but what will happen in your situation? Arbitration clauses have significant ramifications, and you have the opportunity to pick your own rules, and even to write them yourself. Make sure you know which rules you are choosing, and why.

Evendorff and O'Connell are attorneys in the litigation department of Morrison & Foerster's San Diego office.

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