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Publications
Two Issues in Drafting Arbitration Agreements
Real Estate Newsletter
Introduction
The rules of the American Arbitration Association ("AAA") are often incorporated into contracts involving real estate matters, including purchase contracts, partnership agreements, leases and others. Where the AAA rules apply, they impose particular requirements for proceeding in the face of a dispute, something to which transactional lawyers are not always sensitive. Parties contemplating arbitration of a real estate dispute must therefore be familiar with both the terms of the relevant arbitration agreement and the applicable AAA rules to preserve objections and avoid unnecessary delays.
Traditionally, parties to an arbitration have been unsuccessful in challenging the award in court. A recent California case now allows the parties to contract for judicial review of arbitrators' errors of law. Thus, when drafting arbitration agreements, parties must carefully consider whether to include language allowing judicial review.
Pitfall #1: Failure to Understand and Comply with AAA Rules
AAA arbitration rules apply where parties have either agreed to arbitration by the AAA or the application of the AAA's rules. Rule 1. An arbitration agreement that provides disputes are to be resolved in accordance with the procedures set forth in the AAA rules is sufficient to incorporate those rules in their entirety into the terms of the arbitration agreement. See, e.g, Cox v. Ocean View Hotel Corporation, 533 F.3d 1114, 1122 (9th Cir. 2008) (holding that an arbitration provision stating that "disputes . . . shall be settled . . . in accordance with the then current Model Employment Arbitration Procedures of the [AAA]" incorporated the applicable rules into the terms of the contract, including rules regarding initiation of arbitrations).
An arbitration agreement need not explicitly state that arbitration proceedings are to be administered by the AAA or conducted in accordance with AAA rules for this to be the case. Where an arbitration provision states that AAA rules apply but does not specify that the AAA is to administer the arbitration hearings, courts have held that such language requires AAA administration, as the AAA rules specify procedures for initiation and administration of the arbitration. See, e.g., Cox, 533 F.3d at 1122 (holding that employee who had sent a letter to employer requesting arbitration but failing to initiate arbitration under AAA rules did not comply with the terms of the arbitration agreement and failed to properly initiate arbitration); see also, Hetland v. Lincoln Logs Ltd., 41 Fed. Appx. 46 (9th Cir. 2002). Thus, if parties do not wish to have their arbitration administered by the AAA, they must explicitly exclude rules regarding initiation when drafting the arbitration agreement. Even then, it is unclear what the outcome might be if the parties agreed to incorporate all AAA rules except those related to initiation of the arbitration since the AAA will not accept matters where the fee (which can be substantial) has not been paid.
Initiation of an arbitration under AAA rules requires a party to provide a written demand to the other party of its intent to arbitrate. Rule 6. The initiating party must also file the arbitration demand with the AAA together with payment of a filing fee. Id. At that point, the respondent may, but need not, file an answering statement and counterclaim. Id. The AAA maintains a national panel of real estate arbitrators and can appoint such arbitrators once arbitration has been initiated as set forth within the rules. Rules 4-6. A party who tries to shortcut, or otherwise fails to follow these initiation procedures will be unable to resort to the courts to compel arbitration, potentially leading to significant delays in resolving the dispute. See Hetland, 41 Fed. Appx. at 46 (holding that the district court erred in compelling arbitration where the party seeking to compel arbitration "to be conducted in accordance with the Commercial Arbitration Rules of the [AAA]" had failed to follow the AAA rules for initiating arbitration).
Pitfall #2: Failure to Contemplate in Advance the Limited Scope of Judicial Review of Arbitration Awards
Another pitfall common to arbitration of real estate disputes is that parties often do not understand the limited extent to which the arbitration award may be subject to judicial review. Arbitrators are not required to conform to the rules of law, and courts may not weigh the merits of an arbitration award. Cable Connection, Inc. v. DIRECTV, Inc., 44 Cal.4th 1334, 1355 (2008) (citing Moncharsh v. Heily & Blase, 3. Cal.4th 1, 8 (1992)). In essence, parties risk an erroneous decision by arbitrators in exchange for a (hopefully) inexpensive, quick, and conclusive resolution. Moncharsh, 3. Cal.4th at 11-12. This is because, in the interest of maintaining the efficiency and finality of arbitration proceedings, both the Federal Arbitration Act and the California Arbitration Act strictly limit the grounds for review. 9 U.S.C. §10; CCP §§1286.2, 1286.6. "Under both statutes, courts are authorized to vacate an award if it was (1) procured by corruption, fraud, or undue means; (2) issued by corrupt arbitrators; (3) affected by prejudicial misconduct on the part of the arbitrators; or (4) in excess of the arbitrators' powers." Cable Connection, Inc. v. DIRECTV, Inc., 44 Cal.4th 1334, 1344 (2008).
Recently in Cable Connection, however, the California Supreme Court recognized an exception to the judiciary's historically narrow review of arbitration awards, holding that under California law, in certain limited circumstances courts may review arbitrators' decisions for errors of law. 44 Cal.4th at 1362-64. In that case, a class of cable television dealers sued DIRECTV for wrongfully withholding commissions and assessing improper charges. Id. at 1341. The arbitrators ruled in favor of the dealers, and DIRECTV petitioned the court to vacate the award, arguing in part that the award reflected errors of law. Id. at 1342. The California Supreme Court vacated the award and remanded it back to the arbitrators. Id. at 1340. The court emphasized that for parties to an arbitration agreement to "take themselves out of the general rule that the merits of the award are not subject to judicial review, [they] must clearly agree that legal errors are an excess of arbitral authority that is reviewable by the courts." Id. at 1362.
The court reasoned that "forcing parties to choose between the risk of an erroneous arbitration and the burden of litigating their dispute entirely in court" provided little benefit to the judicial system as a whole. Id. at 1363. The holding comports with the policy goal of vindicating the contractual intent of the parties to the arbitration agreement. Id. at 1355-56.
In drafting arbitration agreements, parties should consider whether judicial review of an arbitration award is advisable in the context of that particular contract. If parties choose to take advantage of the Cable Connection holding and incorporate a provision allowing judicial review for legal error, they may be concomitantly imperiling many of the benefits of arbitration, including informality, efficiency, and finality. If the parties do decide to incorporate such language, they should also provide that the clause is to be construed in accordance with California law, as the Federal Arbitration Act does not permit parties contractually to expand the statutory scope of review. Hall Street Assoc., L.L.C. v. Mattel, Inc., 552 U.S. 576 (2008).
Conclusion
Arbitration is intended to provide for the resolution of disputes quickly and with finality. The AAA's procedural arbitration rules work to accelerate dispute resolution by giving arbitrators significant leeway to establish expeditious processes and by relaxing evidentiary rules. See, e.g., Rules 9-12, 31, 33-36. A well-drafted arbitration agreement can supplement and refine these rules to allow for even more efficient proceedings. Parties can fix the locale, specify procedures for selecting arbitrators, and establish deadlines within the arbitration agreement to avoid delays and provide for needed AAA oversight on disputes over these issues. Perhaps more importantly, to avoid significant delays at the onset of proceedings, parties should specify which AAA rules are to apply and whether the AAA itself is to administer the hearings.
Parties must also carefully consider whether the possibility of judicial review for errors of law would be beneficial in their particular circumstance, and they must include appropriate language if they determine that such review is desired. If these considerations are overlooked, a party may find it is without judicial recourse in the event of delays resulting from a failure to comply with AAA procedure, specifically with regard to initiation, or in the event the arbitrators disregard applicable law.
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