To arbitrate or to not arbitrate—That is the question
Arbitration continues to be an increasingly popular method of resolving legal disputes between parties. For example, the American Arbitration Association announced in 2016 that the total international case filings for 2015 had risen to over 1000 cases with the aggregate amount of claims and counterclaims exceeding $8.2 billion.1 The industries in which it reported the greatest growth included construction, franchise, hospitality/travel, insurance, technology, and energy.2 Similarly, the International Court of Arbitration of the International Chamber of Commerce announced a record number of new arbitration cases filed in 2016 – 996 new cases in total involving 3,099 parties from 137 countries.3
In order to decide if arbitration is the best course of action for parties to choose to determine any legal disputes that might arise between them, it is important for an individual or entity to fully understand how arbitration works, the advantages and disadvantages of using arbitration, and how courts view arbitration awards. If a party decides arbitration is its preferred method of dispute resolution there are also a number of things it should consider in terms of how it drafts and negotiates an arbitration provision in any contract it enters into.
Arbitration is a form of alternative dispute resolution whereby parties to a dispute agree to submit their respective positions and evidence to a neutral third-party arbitrator (or panel of arbitrators) who then considers the evidence and makes a binding decision resolving the parties’ dispute. Arbitral decisions are considered final and binding on the parties. Arbitration provisions can be found in many commercial and professional agreements, including attorney-retainer agreements and employment agreements. Arbitration provisions are also quite common in consumer contracts including cellular-phone agreements, residential-mortgage loans, and sales agreements that individual consumers agree to all the time in everyday ordinary sales transactions. Parties can also later agree to arbitrate an existing dispute through a separate contract. The agreement between the parties to submit their dispute to arbitration is a legally binding contract.
In Illinois there are two primary statutory guides that govern arbitrations, the Federal Arbitration Act, 9 U.S.C. § 1, et seq., and the Illinois Uniform Arbitration Act, 710 ILCS 5/1, et seq. The FAA was enacted in 1925 in response to widespread judicial hostility to arbitration agreements and was intended to put arbitration agreements on the same footing as other contracts.4 Section 2 of the FAA, the primary substantive provision of the Act, provides that arbitration agreements “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”5 The Supreme Court has described this provision as reflecting both a “liberal federal policy favoring arbitration,” and the “fundamental principle that arbitration is a matter of contract.”6 The FAA applies to all arbitration agreements involving interstate commerce, including employment agreements not involving transportation workers.7
Similarly, Illinois adopted the Uniform Arbitration Act in 1961 to forward a policy favoring enforcement of arbitration agreements.8 The Act contains the same basic language as the FAA setting forth that an arbitration agreement is valid and enforceable except if there exists any grounds at law or in equity to revoke any contract.9 The Illinois Act applies to those arbitration clauses that do not affect interstate commerce or specifically state that Illinois law will apply.10
Under both statutes, arbitral awards are subject to only the most “limited judicial review.”11 Under the FAA, confirmation of arbitration awards is mandatory. Section 9 of the FAA provides that:
If the parties in their agreement have agreed that a judgment of the court shall be entered upon the award made pursuant to the arbitration, and shall specify the court, then at any time within one year after the award is made any party to the arbitration may apply to the court so specified for an order confirming the award, and thereupon the court must grant such an order unless the award is vacated, modified, or corrected as prescribed in sections 10 and 11 of this title.12
As the Supreme Court has held, “[t]here is nothing malleable about ‘must grant,’ which unequivocally tells courts to grant confirmation in all cases, except where one of the ‘prescribed’ exceptions applies.”13 Section 9 of the FAA “carries no hint of flexibility.”14
Under Section 10 of the FAA, an arbitration award may be vacated only: (1) where the award was procured by corruption, fraud, or undue means; (2) where there was evident partiality or corruption in the arbitrators, or either of them; (3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or (4) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.15 Errors of fact or law – even “serious” errors – are insufficient to vacate an award.16
Illinois courts similarly review arbitration awards so as to uphold their validity “wherever possible.”17 They will “not vacate an arbitration award for ‘mere errors in judgment or mistakes of law;’” but rather, the errors must be significant and plainly apparent on the face of the award.18 The Illinois Arbitration Award sets forth the same limited four grounds as the FAA for vacating an arbitrator’s decision, but in addition includes a provision that a court may vacate an award where “there was no arbitration agreement and the issue was not adversely determined in proceedings under Section 2 and the party did not participate in the arbitration hearing without raising the objection, but the fact that it could not or would not be granted by the circuit court is not ground for vacating or refusing to confirm the award.”19 It is precisely because the parties bargained to not have a judicial determination in the first instance, which courts are reluctant to interfere with an arbitration award outside the limited grounds set forth in the Act.20
Where the FAA and Illinois UAA statutes do diverge is whether a court or arbitrator(s) must decide whether an issue is arbitral under the parties’ arbitration agreement. Under the FAA, the court, not the arbitrator, determines whether individual claims fall within the arbitration agreement.21 Under the Illinois act, however, whether a court or arbitrator decides if an issue belongs in arbitration depends on the arbitration agreement. Where the language of the arbitration agreement is clear, and it is apparent that the dispute between the parties falls within the scope of the arbitration clause, a court should decide the arbitrability issue and compel arbitration.22 Similarly, if it is clear that that the issue does not fall within the arbitration clause, the court should also decide the arbitrability issue and deny any motion to compel arbitration because there is no agreement to arbitrate between the parties.23 But when the language of an arbitration clause is unclear as to whether the subject matter of the dispute between the parties falls within the scope of the arbitration agreement, the court should decline to make a decision and instead the question of whether the issues are to be arbitrated should be decided by the arbitrator.24
Given the deference shown by the courts to arbitration awards, it is important to consider the benefits and potential detriments in agreeing to arbitration. Some advantages to arbitration include the following:
• It is faster and less expensive than litigation because there are less battles over pleadings, discovery can be more limited, and the hearing of evidence can be streamlined;
• The parties can select arbitrators with specialized knowledge about the industry that is at issue in the arbitration;
• The parties can select the arbitration forum and procedure;
• The arbitrators need not follow the strict structure of the law;
• Arbitration is typically confidential;
• There is more flexibility with arbitration regarding scheduling of hearings and discovery, the scope of discovery and the presentation of evidence.
There are also perceived disadvantages to arbitration. Some of those include:
• Arbitrators may be more likely to provide an award that is a compromise between two parties’ position rather than a full victory to one party or the other;
• Arbitrations are not always less expensive in particular if the arbitrator(s) allow pretrial motions and do not limit discovery;
• Parties to an arbitration do not have the right to a jury trial and there is a limited right to appeal the award;
• Depending on the parties’ arbitration agreement, arbitrators may not follow the rule of law;
• Arbitrators do not have to follow the rules of evidence and so evidence may be allowed that would not otherwise be admitted by a court.
Parties should consider both the advantages and disadvantages to arbitration when deciding whether to agree to arbitrate their claims. In addition, if parties agree to an arbitration clause, they should consider whether some of the potential disadvantages to arbitration might be handled by including certain provisions in an arbitration clause. For example, the parties can decide what law will apply to the arbitration clause. Absent selecting a specific law, the arbitration clause will likely be governed the law which applies to the entire contract. But by identifying what law the parties agree applies to the arbitration clause, the parties obtain certainty and agreement on the applicable law.
Similarly, the parties can potentially avoid the uncertainty of what type of pleadings, discovery, and evidence arbitrators will allow by agreeing the rules of evidence do or do not apply, and selecting a set of rules to govern procedure. The International Chamber of Commerce and American Arbitration Association are just two examples of dispute resolution organizations that have set forth sets of rules to govern arbitrations that parties can select to include in their arbitration agreement. By selecting a governing set of rules, everyone knows at the outset what the ground rules will be if there is a dispute to be arbitrated. What procedures are agreed upon can also impact the expense of arbitration. More discovery and motion practice will increase the cost of arbitration as well as the length of time to resolve the parties’ issues. Selecting the location of an arbitration and including it in the arbitration agreement also impacts cost as the parties can take into account the location of the parties, witnesses, and counsel (although that might not be completely known to the parties at the time of drafting the arbitration provision.)
One of the most important items to include in an arbitration agreement is to be clear what matters will be subject to arbitration. This is particularly true given the deference and limited review by the courts over arbitration awards. The parties better be sure they intend to have a dispute decided through arbitration because once an award is issued it will be difficult to get the award vacated.
The parties can decide to submit all disputes relating to the contract to arbitration. The parties can also decide to split matters and have certain disputes decided through arbitration while other disputes will be submitted to the courts. For example, matters involving highly technical issues may be better suited for arbitration where the arbitrator has specialized industry experience and knowledge to assist in deciding those issues. What is most important, however, is that whatever the parties decide they use clear and explicit language to set forth what they agree is the scope of the arbitration agreement. As explained above, the clarity of the language may impact whether a court or arbitrator(s) determine whether a dispute is to be arbitrated.
At the end of the day, an agreement to arbitrate is a contractual agreement between two-private parties, and courts have made clear an intent to uphold the principles of the freedom to contract and to hold parties to their agreement. Parties should carefully weigh the potential upsides and downsides of agreeing to arbitrate disputes in lieu of the civil-court systems. And if the parties decide that they wish to agree to arbitrate their disputes, they should think through and draft carefully the arbitration provision to capture the parties’ agreement.