When drafting contracts, can specificity ever not be a virtue? When a contract leaves material terms open, after all, the contract might be void for indefiniteness. E.g., Boyce v. McMahan, 285 N.C. 730, 734, 208 S.E.2d 692, 695 (1974).
This article addresses an exception to the rule: When drafting an arbitration provision, specificity about the identity of the arbitrator can — if the identified arbitrator is unavailable — lead a court to invalidate the arbitration provision altogether.
This issue is not hypothetical, and it has received varied treatment by different courts. After framing the state of the law in this area, we offer practical advice to use when you draft your next arbitration provision.
I. The Problem: Your Designated Arbitrator Might Become Unavailable.
Good reasons support arbitration provisions that require the use of specific arbitrators. The American Arbitration Association (AAA), for example, has settled rules and procedures; parties who like predictability might want all of their arbitrations to be administered by the AAA.
What happens, though, if the AAA refuses to administer a case? In 2003, the AAA did just that: It announced in its Healthcare Policy Statement (available at http://www.adr.org/aaa/ShowPDF?doc=ADRSTG_011014) that it would no longer administer health-care cases involving individual patients unless the parties had signed a post-dispute agreement to arbitrate. Did the AAA’s decision mean that a pre-dispute agreement to arbitrate that named the AAA as the arbitrator was now invalid?
Another example: In 2009, the National Arbitration Forum (NAF), as part of a settlement with the Minnesota Attorney General, agreed to stop arbitrating any consumer disputes. See CompuCredit Corp. v. Greenwood, 132 S. Ct. 665, 677 n.2 (2012). Did this decision by the NAF mean that arbitration provisions in consumer contracts that specifically designated the NAF as arbitrator were now invalid?
II. The Governing Statutes Appear to Provide a Clear Answer: The Court Shall Appoint Another Arbitrator.
Two statutes might govern an arbitration agreement entered in North Carolina: the Federal Arbitration Act, known as the FAA, or North Carolina’s Revised Uniform Arbitration Act. The FAA applies if the contract “evidences a transaction involving interstate commerce.” King v. Bryant, 737 S.E.2d 802, 806 (N.C. Ct. App. 2013).
Both the FAA and the North Carolina act have “gap-filling” provisions that speak to the identity of the arbitrator — that is, statutory provisions that apply if the parties’ designated arbitrator is unavailable. These statutes provide for the same outcome: If the arbitrator is unavailable, the court “shall” appoint or designate another arbitrator. Compare North Carolina Revised Uniform Arbitration Act, N.C. Gen. Stat. § 1-569.11(a), with Federal Arbitration Act, 9 U.S.C. § 5.
III. When the Designation of an Arbitrator Is “Integral” to the Agreement, an Unavailable Arbitrator Invalidates the Entire Arbitration Provision.
Although this language may seem to resolve the issue, parties trying to avoid arbitration have successfully argued around these statutes.
The argument used to circumvent these statutes goes like this: When an arbitration provision specifically names an arbitrator, it means that the availability of that arbitrator is material to the parties’ agreement. Under basic principles of contract law, when a material provision is frustrated, the contract is rendered impossible to perform. Thus, the unavailability of a specifically named arbitrator means that the entire arbitration provision is void.
Last year, the North Carolina Court of Appeals considered this argument in Crossman v. Life Care Centers of America, Inc., 738 S.E.2d 737 (N.C. Ct. App. 2013). The Crossman case concerned a pre-dispute health-care arbitration provision that named the AAA as arbitrator. The plaintiff, trying to avoid arbitration, argued that because the AAA would not serve as arbitrator, the arbitration provision was void.
The Court of Appeals agreed, holding that the provision’s mandatory language that required the AAA to administer the arbitration showed that use of AAA arbitrators was “an integral and material provision of the Agreement.” Because the AAA would not serve as arbitrator, the provision, according to the Court of Appeals, was impossible to perform. The Court of Appeals rejected the argument that the North Carolina Revised Uniform Arbitration Act changed this interpretation of the arbitration provision.
One month after it decided Crossman, the Court of Appeals addressed a related question in King, 737 S.E.2d at 802. There, a party sought to compel arbitration based on a provision that left two significant terms open for future agreement; the contract required the parties (a) to “agree upon three Arbitrators” and (b) to “agree upon all rules that shall govern the arbitration.” The King court reasoned that these agreements to agree did not render the contract unenforceable, but instead invoked the gap-filling provision of the FAA.
Finally, as this newsletter was being readied for publication, the Court of Appeals issued its opinion in Torrence v. Nationwide Budget Finance, No. COA12-453 (N.C. Ct. App. Feb. 4, 2014). (As a measure of full disclosure, the authors’ law firm represented the defendant-appellants in this case.) Torrence involved a consumer agreement that required the NAF to arbitrate all disputes and also invoked the FAA. The trial court held — as the court had done in Crossman — that the unavailability of the parties’ designated arbitrator rendered the agreement unenforceable. The Court of Appeals reversed, holding that section 5 of the FAA required appointment of a substitute arbitrator, since “the key aspect of the analysis of an agreement to arbitrate is the intent of the parties to arbitrate, not the identity of the arbitrator.” The court did not mention its opinion in Crossman, which was decided under North Carolina law, rather than the FAA.
The decisions from Crossman, King, and Torrence show two important points: First, an arbitration provision that leaves open the identity of the arbitrator may be more likely to be upheld than an agreement that names a specific — but unavailable — arbitrator. Put another way, fewer details about the arbitrator’s identity actually enhances enforceability. Second, invoking the FAA could improve the likelihood of ensuring arbitration despite changed circumstances, as North Carolina courts may be reluctant to parse the gap-filling provision of the federal statute.
Other courts across the country have reached varied conclusions on these issues. See Meskill v. GGNSC Stillwater Greeley LLC, 862 F. Supp. 2d 966, 972 (D. Minn. 2012) (describing split of authority among courts). Ultimately, though, many courts use essentially the same framework as that described in Crossman: Was the designation of a specific, but now unavailable, arbitrator “integral to the arbitration provision,” or was it “merely an ancillary consideration”? Khan v. Dell, Inc., 669 F.3d 350, 354 (3d Cir. 2012).
Under this framework, “a court will decline to appoint a substitute arbitrator, as provided in the FAA, only if the parties’ choice of forum is so central to the arbitration agreement that the unavailability of that arbitrator brings the agreement to an end.” Id.
IV. Principles to Enhance Enforceability
Read as a whole, the court decisions in North Carolina and across the country offer principles that, if employed, increase the likelihood that your client’s arbitration provision will be upheld:
Acknowledge that circumstances may change. If your client insists on naming a specific arbitrator, also include a statement that arbitration should go forward even if that arbitrator becomes unavailable. Last year, an appellate court in Indiana upheld an arbitration provision that named the NAF as arbitrator, but also said that, if the NAF cannot serve as arbitrator, the parties will agree on another method for arbitration. Anonymous, M.D. v. Hendricks, 994 N.E.2d 324, 331 (Ind. Ct. App. 2013). Similarly, a federal district court in New York compelled arbitration when a provision named the NAF as the arbitrator but also expressly said that, if the NAF ceases to exist, the parties would agree on another arbitrator. Crewe v. Rich Dad Educ., 884 F. Supp. 2d 60, 77 (S.D.N.Y. 2012).
Invoke the Federal Arbitration Act. Even if the contract does not involve interstate commerce, parties may “affirmatively choose the FAA to govern an agreement to arbitrate.” King, 737 S.E.2d at 806. Why might this be a good idea?
First, invoking the FAA may avoid a direct conflict with the Crossman decision, which interpreted the North Carolina arbitration statute and, as discussed above, invalidated an arbitration provision that named a specific, but unavailable, arbitrator. The decision in Torrence further suggests that North Carolina courts may be more reluctant to invalidate arbitration agreements that invoke the federal statute.
Second, several cases applying the FAA take a critical view of the “integral versus ancillary” test in general; these decisions say that an arbitrator’s unavailability should never void an agreement. As one court wrote, “When a court declares that one or another part of an arbitration agreement clause is ‘integral’ and that the clause is therefore unenforceable as a matter of federal common law, it is effectively disagreeing with Congress, which provided that a judge can appoint an arbitrator when for ‘any’ reason something has gone wrong.” Green v. U.S. Cash Advance Ill., LLC, 724 F.3d 787, 791 (7th Cir. 2013); see also Adler v. Dell Inc., No. 08-cv-13170, 2009 WL 4580739, at *4 (E.D. Mich. Dec. 3, 2009) (rejecting any inquiry into what the parties deemed “integral” to the agreement because “the FAA omits any mention of parsing through the parties’ intent”).
Finally, the FAA carries a related benefit: It helps ensure that a forum-selection clause designating a forum other than North Carolina will be enforceable. Although North Carolina law voids forum-selection clauses that require a non-North Carolina forum for contracts entered in the state — see N.C. Gen. Stat. § 22B-3 — the FAA preempts this restriction, reinstating the parties’ right to contract for a different forum. E.g., U.S. ex rel. TGK Enters., Inc. v. Clayco, Inc., — F. Supp. 2d —, 2013 WL 5348464, at *7 (E.D.N.C. 2013).
Use “exclusive” and “shall” sparingly, at least when referring to specific arbitrators. The designation of specific arbitrators has been found to be integral to an arbitration provision when the provision uses mandatory language to designate the arbitrator. For example, in voiding an arbitration agreement that named the NAF as the exclusive arbitrator, the Wisconsin Supreme Court stated that “the repeated use of mandatory, not permissive, language demonstrates the parties’ specific intent to use the NAF Rules of Procedure, as well as their intent that NAF is integral to the arbitration agreement.” Riley v. Extendicare Health Facilities, Inc., 826 N.W.2d 398, 409 (Wisc. 2012). The Court of Appeals of Georgia recently ruled similarly: “The Arbitration Agreement’s use of the mandatory ‘shall’ and the word ‘exclusively,’ together with its express incorporation of the NAF Code, indicates that the parties did not have a general agreement to arbitrate; rather, they contracted to arbitrate only before the NAF.” Miller v. GGNSC Atl., LLC, 746 S.E.2d 680, 686 (Ga. Ct. App. 2013).
Expressly mention arbitration in the severance provision. Most commercial contracts include a severance provision, saying that if any provision of the contract becomes unenforceable, the rest of the contract remains in place. Where the designation of an unavailable arbitrator creates an unenforceable term, courts have used severance provisions that specifically mention arbitration to justify compelling arbitration; these courts simply disregard the designation of the unavailable arbitrator and otherwise enforce arbitration. E.g., Meskill, 862 F. Supp. 2d at 976; Jones v. GGNSC Pierre LLC, 684 F. Supp. 2d 1161, 1167-68 (D.S.D. 2010). In contrast, a “boilerplate severance clause” in a broader agreement may not save an arbitration provision that was rendered impossible owing to a designated arbitrator’s unavailability. See Rivera v. Am. Gen. Fin. Servs., Inc., 259 P.3d 803, 815 (N.M. 2011).
Weigh the risk of imposing penalties for seeking a different forum. In a recent decision, the Illinois Supreme Court concluded that an arbitration provision’s designation of the NAF was integral to the agreement — and therefore struck down the arbitration provision — in large part owing to a penalty clause. Carr v. Gateway, Inc., 944 N.E.2d 327, 336-37 (Ill. 2011). The penalty clause empowered the arbitrator to award expenses and attorney fees if a party brought a case in a forum other than before the NAF. This provision showed that the parties wanted to arbitrate only before the NAF; once the NAF made itself unavailable, the arbitration provision failed as impossible to perform.
V. Conclusion: Every Word Matters
As the law in this area continues to evolve, parties who want to enhance the enforceability of their arbitration provisions should take a conservative approach. That approach requires careful attention to each word of an arbitration provision. Every word that suggests the designation of a specific arbitrator is integral to the agreement increases the risk that, if the specific arbitrator becomes unavailable, the entire arbitration provision will be invalidated.
*This article originally appeared in the February 2014 issue of Notes Bearing Interest(https://businesslaw.ncbar.org/newsletters/notesbearinginterestfebruary2014)