Thought Leaders: Mandatory arbitration clauses within contracts
Allison MacKenzie sponsors this content
November 26, 2018
In general, when parties enter into a contract, they do not contemplate potential legal disputes arising in the future. However, it is important for parties to outline how they will handle a contractual dispute if one does occur. Including an arbitration clause in a contract will help to eliminate some of the litigation costs and uncertainties that may transpire if a dispute over a contract should develop.
A mandatory arbitration clause is a provision contained within a contract that states that all legal disputes between the parties to the contract will be settled through the process of arbitration. Arbitration clauses are very common and can be found in various types of business contracts including: purchases for goods or services, employment contracts, construction contracts, etc.
Many sophisticated parties and businesses include a mandatory arbitration clause in their contracts because it enables them to settle legal disputes regarding the contract quickly, quietly and without the expense of litigation.
Arbitration is the process of settling a legal dispute between two or more parties using an impartial third person. Therefore, if a dispute arises regarding a provision of the contract that cannot be resolved between the parties themselves, the parties will present their issues to an arbitrator, or neutral third party, instead of through traditional litigation proceedings.
There are many professional arbitrators and organizations that parties may choose from. Some of these specialize in the specific area of the law or business issue. The selection process may be (but is not necessarily) specifically included within the language of the arbitration clause. Generally, the arbitration clause will outline who pays for the arbitration, whether each pays half of the cost of the arbitrator and their own attorney's fees or whether the non-prevailing party pays these expenses.
Generally, an arbitration clause will state where the arbitration will take place and what law will govern the dispute, should one arise. For instance, if a contract is entered into in Nevada, the arbitration clause will likely state that the contract dispute must be arbitrated in Nevada. It is very important to include within the mandatory arbitration clause, the state and/or location of where the arbitration must take place and the governing law within the arbitration clause to avoid confusion and conflict.
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If there is not a specific provision within the contract regarding which law applies, then depending on the nature of the contract, the arbitration clause may be governed under federal or state law. The Federal Arbitration Act (FAA) governs agreements where the contract involves a transaction that crosses state lines, also known as "affecting interstate commerce."
If the contract does not deal with interstate commerce, then state law will apply. There are several factors to take into consideration when determining exactly which state law applies; however, for the purposes of this article, it is assumed that Nevada law will apply to the arbitration clause.
If the arbitration provision in the contract is governed by Nevada law, there are some specific requirements that must be met before the provision is enforceable. Nevada Revised Statutes (NRS) Chapter 38 governs arbitration provisions within contracts. In Nevada, arbitration agreements between parties to a contract are favored as a matter of public policy because they allow for judicial economy and ease the burden of the courts.
While arbitration agreements are favored, Nevada law sets a higher standard of enforcement for arbitration clauses contained within contracts than most states and the FAA. NRS 597.995(1) requires "specific authorization" of the arbitration clause by each of the parties to the contract.
If "specific authorization" is not provided by the parties, it can render the arbitration clause void and unenforceable. If a mandatory arbitration clause is found to be unenforceable or void, a party can choose to litigate the dispute through the court system and is no longer bound by the contract to arbitrate its claims.
While the statute does not expressly state what "specific authorization" means, the Nevada Supreme Court has given some idea of what constitutes specific authorization under NRS 597.995(1). In Fat Hat, LLC v. DiTerlizzi (2016), the Court found that a signature of a party to the contract on the general signature line at the end of the contract did not meet the specific authorization requirement.
The Court found that, even though the arbitration agreement contained within the contract was right above the signature line, it did not constitute specific authorization. While this case is unpublished and therefore is not controlling in future cases, it may be persuasive as to how a court will view the statutory specific authorization requirement.
To ensure that Nevada's specific authorization requirement is met, it is important that an agreement includes an additional signature or initial line directly below the arbitration clause to ensure that each party assents to the arbitration clause. By including an additional signature or initial line to the arbitration provision the "specific authorization" requirement will likely be met and ensure that the arbitration clause within the contract is enforceable.
The take away…in order to ensure that an arbitration provision is enforceable, the contract must include the following:
- The arbitrator or group identified to arbitrate the dispute;
- Who will pay for the legal and arbitrator fees;
- The governing law that is to apply to the contractual dispute;
- A signature or initial line set apart from and directly below the arbitration provision to ensure that the "specific authorization requirement is met."
It is recommended that you seek the assistance of knowledgeable legal counsel in developing and reviewing these clauses in order to protect the future of your business dealings should a conflict arise.
This article was written by Jennifer McMenomy, an attorney with Allison MacKenzie in Carson City, which sponsors this content.