One of the most frequently overlooked provisions of a contract is the arbitration clause. Generally, an arbitration clause provides that the parties to the contract agree that in the event of a dispute which arises out of the contract, the parties shall have that dispute heard before an arbitrator – not a judge.

Serious consequences can flow from an arbitration clause. For instance, in arbitration a party does not have the right to a jury trial. Arbitration can be beneficial in that it is intended to reduce the cost of having a dispute resolved in court. Many contracts contain “boilerplate” arbitration clauses, which may not adequately reflect the parties’ agreement as it relates to arbitrating any disputes. A properly drafted arbitration clause is important in order to avoid costly legal battles over the interpretation of an arbitration clause. Some of the many items that should be specifically stated in the arbitration clause are discussed below.

Typically, breach of contract disputes or claims will also contain fraud and other contractually tortuous related claims. At least one federal court has held that an arbitration clause providing for arbitration of claims “arising under” the contract was not broad enough to cover a claim for tortuous interference with contractual relations. A narrowly drawn arbitration clause or boilerplate language may severely limit the types of disputes or claims that can be arbitrated.

If desired, the arbitration clause should be drafted as broadly as possible to encompass all types of potential disputes or claims. The parties, however, may want only specific claims arbitrated, leaving other claims for the court to decide. Whatever the parties intent, it should be clearly set forth in the arbitration clause that is part of the contract.

Separate and apart from the types of claims and disputes that can be arbitrated, the arbitration clause should also address what issues the arbitrator can decide. Many times a party who feels it is disadvantageous for him/her to arbitrate a particular claim will challenge the validity of the arbitration clause itself. If the arbitration clause is silent as to who will decide this initial issue, thousands of dollars could be spent litigating that very issue before a judge. This may run contrary to the parties’ intent of having a cost-effective way of resolving the parties’ dispute. Specifically stating the issues that the arbitrator can decide eliminates the uncertainty of which issues the arbitrator can address when the arbitration procedure actually becomes necessary. Remember that once parties are embroiled in a dispute, it is unlikely that there will be any agreement as to the meaning of the arbitration clause if it is unclear or ambiguous. Having clear definitive language will help reduce any uncertainty.

Any contract that involves interstate commerce (generally, where good travel beyond the borders of the State of Arizona) is governed by the Federal Arbitration Act. A problem arises in that many contracts provide that a particular state law will govern the dispute. This has been interpreted to mean that the state law governs the arbitration procedure as well. The Federal Arbitration Act and state law vary widely state to state. For instance, in New York, an arbitrator is prohibited from awarding punitive damages under state law.

The arbitration clause could also be utilized to limit overreaching punitive damage awards. If the arbitrator is allowed to award punitive damages in a particular state, such as in Arizona, it may be possible by agreement to limit or cap the award of punitive damages. One must be careful, however, not to totally exclude punitive damages because a court may not allow such an exclusion under public policy or may then even invalidate the entire arbitration clause. This is especially true where there may be unequal bargaining power between the parties.

The entity that will perform the arbitration should be clearly identified in the arbitration clause. One of the largest arbitration companies is the American Arbitration Association. Further, because of the nature of the dispute, particular qualifications may be necessary. One may want to specify those qualifications that are necessary for the arbitrator to possess before one may be selected. For instance, under the American Arbitration Association rules, if no particular qualifications are specified, the parties may choose from a list of arbitrators with only a certain number of strikes available. Thus, one may end up with an arbitrator who is not entirely qualified to resolve the dispute.

One of the most important parts of the arbitration clause is the identification of the locale in which the arbitration will take place. If the contract is between parties that reside in different states, having the locations firmly established may save a party time and money in prosecuting and maintaining the arbitration. This is particularly true where there is great distance between the contracting parties.

Some states now have laws that prohibit the selection of a particular location for arbitration in certain types of agreements; i.e., franchise agreements. A check of the particular state laws should be accomplished in order to ensure that the location agreed upon could not be challenged after a dispute has arisen. Under recent U.S. Supreme Court rulings, it is possible that state statutes restricting the ability to choose a location for arbitration purposes may be unconstitutional and therefore invalid. This, however, remains an open and developing area of the law.

The arbitration clause should also state that an arbitrator provide a written opinion of the facts and conclusions of law and follow “applicable law and judicial precedent.” If this is not designated, it is possible that an arbitrator may not have to follow the laws of the state in which the transaction took place. This is because the American Arbitration Association rules, for instance, only provide that the arbitrators must make the award that they deem just and equitable. Courts have interpreted this to mean that an arbitrator does not have to follow the law of the state. By requiring a written opinion of facts and conclusions of law, the parties can agree that judicial review of that award is limited to finding errors of law made by the arbitrator.

These are just a few of the areas that should be addressed in any arbitration clause. Many contracts, however, contain the standardized boilerplate arbitration clause language, which may be inadequate under current standards. A legal checkup of your contract arbitration clause may be in order.

This article is for general information purposes only and does not constitute legal advice. If you have any questions about contract law, consult an attorney.