It would behoove the parties that enter into contracts that include an arbitration clause to provide an alternative to their favored ADR entity.
For decades, scriveners (aka transactional lawyers) have been carefully avoiding litigation by inserting arbitration clauses into their contracts.
Some lawyers use generic terms in referring to an ADR provider, while others specify a provider with whom they are familiar in their community or one that they believe would be specifically knowledgeable in their area of business. There are even some providers that have become industry-specific, e.g., nursing home patient cases or employment cases.
Problems arise in matters where a specific ADR provider is in the agreement and no longer exists (or has been precluded from practicing in your state) and the issue becomes whether the court will assist you in getting another ADR provider. In a recent case, the Supreme Court of the state of Missouri, sitting en banc, affirmed a Circuit Court decision that refused to compel arbitration despite the existence of an arbitration clause.
The Missouri Supreme Court, in affirming the circuit court below, confirmed the court’s position in refusing to compel arbitration specifically “[b]ecause the plain language of the parties’ arbitration agreement shows they agreed to arbitrate before—but only before—the National Arbitration Forum (‘NAF’).” A-1 Premium Acceptance v. Hunter, 557 S.W.3d 923, 924 (Mo. 2018), cert. den. 139 S.Ct. 1340 (2019).
In the A-1 case, the agreement between A1 (the lender) and Hunter (the borrower) read, in relevant part that:
… and any claim or dispute related to this agreement or the relationship or duties contemplated under this contract, including the validity of this arbitration clause, shall be resolved by binding arbitration by the National Arbitration Forum, under the Code of Procedure then in effect. Any award of the arbitrator(s) may be entered as a judgment in any court of competent jurisdiction. Information may be obtained and claims may be filed at any office of the National Arbitration Forum or at P.O. Box 50191, Minneapolis, MN 55405. This agreement shall be interpreted under the Federal Arbitration Act. (Underlining emphasis supplied by author. Bold and italics emphasis is found in decision of the court).
Id. at 924-25.
Section 5 of the Federal Arbitration Act provides:
If in the agreement provision be made for a method of naming or appointing an arbitrator or arbitrators or an umpire, such method shall be followed; but if no method be provided therein, or if a method be provided and any party thereto shall fail to avail himself of such method, or if for any other reason there shall be a lapse in the naming of an arbitrator or arbitrators or umpire, or in filling a vacancy, then upon the application of either party to the controversy the court shall designate and appoint an arbitrator or arbitrators or umpire, as the case may require, who shall act under the said agreement with the same force and effect as if he or they had been specifically
named therein; and unless otherwise provided in the agreement the arbitration shall be by a single arbitrator. 9 U.S.C. §5 (2012) (emphasis in decision).
A-1, 557 S.W.3d at 926.
In 2009, the Minnesota Attorney General’s office entered into a consent decree with NAF requiring it to stop its arbitration services nationwide. A-1, as lender, had required that its borrowers agree to arbitration with NAF as a condition of obtaining loans with A-1.
Now that NAF was unavailable, A-1 reached out to the court, through §5 of the Federal Arbitration Act, to compel arbitration. The court refused to do so at every level: trial term, Circuit Court and Supreme Court.
In refusing to compel arbitration, the Supreme Court ruled:
The FAA “reflects the overarching principle that arbitration is a matter of contract … [a]nd consistent with that text, courts must rigorously enforce arbitration agreements according to their terms, including terms that specify with whom the parties choose to arbitrate their disputes and the rules under which that arbitration will be conducted.” (Internal citations omitted).
* * *
Accordingly, for purposes of analyzing the issue presented in this case, there are two types of arbitration agreements: (1) agreements in which the parties agree to arbitrate regardless of the availability of a named arbitrator, and (2) agreements in which the parties agree to arbitrate before but only before a specified arbitrator. If the former, section 5 of the FAA authorizes and requires courts to name a substitute arbitrator when the agreement fails to identify one or fails to provide a means for naming a substitute. If the agreement is of the latter type, however, nothing in the FAA authorizes (let alone requires) a court to compel a party to arbitrate beyond the limits of the agreement it made. Employing this analysis, the Court holds A-1 and Hunter agreed to arbitrate before but only before NAF and, as a result, the circuit court did not err in refusing to compel Hunter to arbitrate before some other arbitrator under the auspices of section 5 of the FAA.
Id. at 926.
The Missouri court clearly noted: “The unequivocal, plain and clear terms of this Agreement establish that A-1 and Hunter agreed only to arbitrate before NAF. A-1 drafted this provision and it freely chose to require such an agreement from Hunter (and other borrowers) as a condition of obtaining loans from A-1. Having made the choice to insist upon NAF and only NAF as the arbitration forum, A-1 cannot now look to section 5 of the FAA to expand the arbitration promise it extracted from Hunter in the Agreement.” Id. at 928 (emphasis added).
The Supreme Court of Missouri concluded that:
… merely identifying an arbitrator in an arbitration agreement without more cannot justify refusing to name a substitute under section 5 of the FAA on the ground the parties’ agreement was limited to arbitrating before but only before the identified arbitrator. Instead, there must be a basis to
conclude the parties’ arbitration agreement was limited to the specified arbitrator. Here, the plain language of the Agreement provides that basis.
Id. at 929.
While clearly each case of this nature must be evaluated on its specific facts, this case could be considered as a warning to drafters of arbitration clauses of the danger of locking themselves into arbitration with a sole arbitrator without an alternative fallback.
Severability: Another Way To Save the Arbitration Clause
Over 50 years ago, in Prima Paint v. Flood & Conklin Manufacturing, 388 U.S. 395 (1967), the U.S. Supreme Court concluded that under the U.S. Arbitration Act of 1925 courts must enforce an arbitration clause even if there is a claim of fraud in inducement of the agreement that contains the clause (in the absence of evidence that the parties intended to withhold that issue from arbitration). Prima Paint is frequently referenced as an early example of how far the U.S. Supreme Court is willing to go to preserve an agreement to arbitrate.
Thus, separability, now more frequently called severability, would be another method of saving the arbitration portion of a contract even if the arbitrating entity never existed or no longer exists. A judge might need a very sharp scalpel to do it, but it clearly may be done.
In a recent case out of the Court of Appeals in Ohio (the second highest appellate court in Ohio), Paulozzi v. Parkview Custom Homes, 2018-Ohio-4425, 122 N.E.3d 643, the court enforced the severability clause of the contract, thereby saving arbitration, despite the fact that the chosen forum no longer existed.
The lower court had found that the arbitration provision of the contract was “impossible to perform” and, therefore, unenforceable pursuant to the Ohio Arbitration Act, in that “[t]he arbitration agreement did not provide an alternative arbitration forum.”
The Court of Appeals disagreed. It found the agreement was not unenforceable due to impossibility because it was “still possible to arbitrate the issues between the parties despite [the arbitration entity’s] absence.” Id. at 649. The court continued that “to hold otherwise would defeat the parties’ intentions when they entered into the contract and agreed to arbitrate the dispute.” Id. at 650.
The Ohio court stated that it was appropriate to apply the severability clause in the parties’ contract, noting further that severability “depends generally upon the intention of the parties, and this may be ascertained by the ordinary rules of construction.” Id. at 651, citing Ignazio v. Clear Channel Broadcasting, 2007-Ohio-1947, ¶11, 113 Ohio St.3d 276, 865 N.E.2d 18.
Thus the Ohio court, relying on the underlying intent of the parties, used the severability clause to save the parties’ decision to arbitrate.
How Would These Cases Be Decided in New York?
Arbitration in New York is controlled by Article 75 of the CPLR. More specifically, the issue of
when the court is called upon to appoint an arbitrator is dealt with in CPLR §7504, mirroring closely §5 of the FAA:
Court Appointment of Arbitrator
If the arbitration agreement does not provide for a method of appointment of an arbitrator, or if the agreed method fails or for any reason is not followed, or if an arbitrator fails to act and his successor has not been appointed, the court, on application of a party, shall appoint an arbitrator.
In matters where a named arbitration provider or arbitrator currently fails to exist, never existed, or no longer does a specific type of arbitration or mediation, there would appear to be a fairly bright line that may be followed by New York practitioners.
In three cases decided over a 20-year period between 1956 and 1976, the Appellate Division either sent a matter back to trial term to hold a hearing on the intent of the parties or determined that the intent was clear from the unambiguous language of the parties.
In Golenbock v. Komoroff, 2 A.D.2d 742 (1st Dept. 1956), it was not clear whether the parties to a partnership agreement intended that only a named individual, and no one else, could arbitrate their differences or that arbitration “generally” was their object.
In a one-paragraph, per curiam opinion, the majority ruled that under the circumstances “it would seem advisable to remit the matter to Special Term for the purpose of having testimony taken as to the intention of the parties.” Id. at 742.
There was a rather strong dissent from Judge Botein who noted that the court “should decline to appoint a substitute for the person agreed upon unless the willingness of the parties to submit to such a substitute is reasonably apparent.” Id. at 743. (Judge Botein clearly did not think that was the case.)
He continued that “[n]o one is under a duty to resort to arbitration unless by clear language he has so agreed.” Id. at 743, quoting Matter of Lehman v. Ostrovsky, 264 N.Y. 130, 132 (1934).
In another First Department case, Laboratorios Grossman. S.A. v. Forest Labs., 31 A.D.2d 628 (1st Dept. 1968), the court was faced with an agreement that named an arbitration organization that did not exist.
The court noted that the parties had different opinions as to what their agreement meant; arbitration only with this non-existent entity, an arbitration only in Mexico, or arbitration under the auspices of the Inter-American Commercial Arbitration Commission. The bottom line is that the “dominant purpose of the agreement was to settle disputes by arbitration rather than the instrumentality through which arbitration should be effected.” Id. at 629 citing Golenbock, 2 A.D.2d at 742.
Again, if the agreement is ambiguous on its face, the intent of the parties should be determined by a hearing at trial term/Special Term.
The most “recent” case is Zandman v. Nissenbaum, 53 A.D.2d 837 (1st Dept. 1976).In Zandman, a member of a professional dentistry corporation brought an action for a preliminary injunction to prevent his expulsion from the dentistry practice.
The agreement among the members provided that disputes should be arbitrated under the rules of the American Medical Association. The problem was that the AMA did not provide for arbitration of such issues.
Special Term appointed a referee to determine the intent of the parties and denied the preliminary injunction. The Appellate Division, First Department, reversed, ruling that the language of the parties’ agreement “is unambiguous. The language used clearly requires that disputes be settled by arbitration. Where the forum designated for arbitration is inappropriate or fails for any reason, the Court is empowered to appoint an arbitrator (CPLR 7504).” Id. at 838 (exact language of agreement not in the decision). The Appellate Division thus directed Special Term to appoint an arbitrator rather than a referee.
It would behoove the parties that enter into contracts that include an arbitration clause to provide an alternative to their favored ADR entity. That clause should clearly indicate the intent to arbitrate, if that is your goal, not merely naming the provider of arbitration services. The inclusion of a severability clause, though commonplace in most contracts, should not be overlooked by the draftsman as another form of insurance to save the parties’ intent to arbitrate.
Reprinted with permission from the November 27, 2019 edition of the New York Law Journal © 2019 ALM Media Properties, LLC. All rights reserved.
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