Views

Avoiding ‘Unfair’ Arbitration: Two Solutions and One Cautionary Tale

Does five against two make for a fair fight? The respondents in a recent arbitration didn’t think so.

Catic USA (“Catic”) is an aviation-focused California corporation owned by a Chinese parent company. After an arbitration panel handed an unfavorable opinion to Catic following a dispute with its investors, the corporation sought relief in court. The arbitration process, Catic argued, was unfair because five of the seven arbitrators on the panel were appointed by the claimants in the dispute, while Catic and a co-respondent chose only two.

“The bottom line is that courts aren’t necessarily going to save you from an arbitration provision even if it seems to work out in a way that’s not fair.”

The U.S. Fifth Circuit Court of Appeals, however, was unmoved by Catic’s argument. The opinion noted that the arbitration agreement governing the proceedings — one signed long before the dispute arose — stated that each party could appoint its own arbitrator.

“This case involves two sides, but, more importantly, it features seven members,” Circuit Judge Jerry E. Smith wrote in his opinion in Soaring Wind Energy, L.L.C. v. Catic USA Inc. Catic, he wrote, “cannot escape the conclusion that the agreement’s written procedure was followed.”

“What the 5th Circuit says, in the opinion, is that the party that ended up outnumbered in terms of party-appointed arbitrators may not have envisioned such an outcome when it agreed to the arbitration procedure . . . but that’s their problem, basically,” explained Jamie Leader, a senior associate in Commercial & Business Litigation at V&E. “I don’t think anybody would argue that a five-versus-two party-appointed arbitration panel doesn’t smell a little funny. But if that’s the result of the procedure you agreed to, then you’re not going to get help from the court.”

Leader added, however, that the 5th Circuit’s opinion shouldn’t be read as a universal rejection of equitable doctrines in the arbitration context.

“Federal courts consider equitable doctrines such as estoppel when deciding whether or not a particular party can be compelled to arbitrate. Additionally, where contract language is ambiguous, or at least subject to multiple interpretations, courts may consider fairness principles in seeking to determine the parties’ original intent,” he said. “The message of Catic, though, is that when an arbitration provision unambiguously requires a certain procedure, courts are unlikely to rewrite that provision to change the procedure.”

So how can companies negotiating arbitration agreements ensure that they don’t suffer Catic’s fate? In other words, how do they avoid striking arbitration agreements that could yield seemingly imbalanced procedures?

The key, said Leader, is to invest the time and resources necessary to craft bespoke agreements. “Don’t do it halfway,” he said. “If the proper resources are dedicated upfront, a process tailored to the needs of the parties can be the best way to ensure that the benefits of arbitration as an alternative to the court system outweigh its costs.”

An arbitration agreement tailored to a company’s particular interests may include, for instance, provisions for more vetting of arbitrators or more time to respond to various requests during arbitration proceedings.

Companies should also do their best to envision what sort of disputes could arise in the future and, under the guidance of their attorneys, plan accordingly.

“What you’ve really got to do is sit down and map out the kind of fights you could have and make sure that you’re not going to be disadvantaged under your arbitration structure,” Leader said. “It requires real thought and collaboration between the transactional lawyers, the company and, potentially, litigators who have seen how bespoke arbitration provisions can go wrong.”

When companies run into trouble, he added, it’s usually because they’ve opted against crafting a fully tailored agreement but instead just “tinkered” with default arbitration rules set by organizations like the American Arbitration Association (AAA) or the International Chamber of Commerce (ICC).

“You don’t want a middle ground where you’re tinkering with the default rules but you’re not doing it in a fully thoughtful way,” he said.

So what can companies that can’t devote the resources necessary to customizing an agreement do? Leader recommends sticking to AAA or ICC rules. “If contracting parties are not prepared to dedicate the resources needed to fully study any changes in procedure, relying on the default rules may be the wiser course,” he said.

For Catic, doing so might have provided the company with a more favorable arbitrator selection process. As an example, under AAA’s Commercial Rules, the AAA, rather than the parties, appoints all arbitrators in situations where there are more than two claimants or respondents.

“If you’re going into a really complicated corporate investment structure and you over-manage how you want the arbitration to play out, then you’re going to be held to that setup,” Leader said. “Whereas, if you kick it to an arbitral organization, they’ll have the power and the discretion to structure it in a way that it seems fair.”

While it’s not guaranteed that other courts will follow the 5th Circuit’s lead, the recent Catic case shows that companies can’t be too careful in setting their arbitration parameters. “The bottom line is that courts aren’t necessarily going to save you from an arbitration provision even if it seems to work out in a way that’s not fair,” Leader said.