Drafting ADR Clauses for Financial, M&A, and Joint Venture Disputes

IN BRIEF

  • The inclusion of an ADR clause in financial, M&A, and joint venture deals is increasingly favored because of its myriad benefits when compared to litigation.
  • A savvy transactional attorney will understand the nuances of the ADR clause and how customizing an ADR clause can be greatly beneficial (or very detrimental if drafted poorly).
  • What are some examples of sample problem clauses of which to be aware?

Many enterprises and lawyers that handle financial, M&A, and joint venture transactions are now turning to alternative dispute resolution (ADR) processes as an effective way to resolve disputes. ADR institutions have seen a significant increase in these types of disputes over the last few years. Unfortunately, contract drafters oftentimes fail to appreciate the nuances of ADR or the various options that should be considered at the front end for a possible dispute down the road. Business corporate lawyers should include the litigators in their firms in this drafting process because the litigators will be in charge of any form of ADR process, be it mediation or arbitration, once the deal is complete and should a dispute arise.

Furthermore, as one of the institutional ADR providers, JAMS (formerly Judicial Arbitration and Mediation Services) notes: “Planning is the key to avoiding the adverse effects of litigation. The optimal time for businesses to implement strategies for avoidance of those adverse effects is before any dispute arises.” JAMS recommends “that whenever you negotiate or enter into a contract, you should carefully consider and decide on the procedures that will govern the resolution of any disputes that may arise in the course of the contractual relationship. By doing this before any dispute arises, you avoid the difficulties of attempting to negotiate dispute resolution procedures when you are already in the midst of a substantive dispute that may have engendered a lack of trust on both sides.”

The American Arbitration Association (AAA) states: “Alternative dispute resolution (ADR) allows parties to customize their dispute resolution process. Parties can insert the standard arbitration or mediation clause in their contract and can further customize their clause with options that control for time and cost.”

A well-written dispute resolution clause is the foundation of an effective dispute resolution process, and parties who draft these agreements most likely want an efficient, meaningful, and enforceable outcome. Flawed arbitration clauses may result in court intervention if disputes arise before the appointment of an arbitrator, during the arbitration, or afterward. So how do you decide what you will need within the provision? Is a simple, standard ADR provision too little protection, and can you “over-draft” a provision? Or is there some sort of “Goldilocks” provision that delivers the “right answer” each and every time? The answers to these questions can be “yes,” “no,” “perhaps,” “often,” “occasionally,” and many more. It truly just depends.

The Standard Clause

If a dispute arises from or relates to this contract or the breach thereof, and if the dispute cannot be settled through direct discussions, the parties agree to endeavor first to settle the dispute by mediation administered by the American Arbitration Association under its Commercial Mediation Procedures before resorting to arbitration. The parties further agree that any unresolved controversy or claim arising out of or relating to this contract, or breach thereof, shall be settled by arbitration administered by the American Arbitration Association in accordance with its Commercial Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.

A standard arbitration clause is often chosen and is the best choice for ease in contract drafting and negotiation. By invoking a provider’s rule set, the standard clause provides a complete set of rules and procedures and eliminates the need to spell out each contingency and procedural matter. When combined with the organization’s case management services, the clause provides a simple, time-tested means of resolving disputes that has proven highly effective in hundreds of thousands of disputes.

By providing for mediation first, the parties have an opportunity to resolve their dispute early. Although sometimes a dispute might not be “ripe” for this facilitated step, many times it can serve to dispose of smaller, less complicated disputes almost immediately or serve to narrow the issues that might then proceed to the arbitration. It can therefore eliminate the need for arbitration and/or streamline the remaining unresolved issues, resulting in greater efficiency and cost savings. Anecdotally, it is said that mediation resolves around 80-85 percent of all cases, which if true or even remotely true, could be reason enough to consider its inclusion in a dispute resolution clause.

Should mediation prove unsuccessful, arbitration is included to provide a mechanism to fully and finally resolve “any unresolved controversy or claim.” This provision allows the institution and the rule set to manage the proceedings, including (among other things) arbitrator selection and appointment, managing challenges, collecting and dispersing arbitrator compensation, and general assurance that the case will keep moving toward a speedy resolution. Once the arbitrator (or panel of three arbitrators) is in place, the standard arbitration provision provides the arbitrator(s), advocates, and the parties the most flexibility to address the specific needs of a particular dispute and then craft an appropriate process to follow through to an award.

The Custom Clause

There are as many reasons to customize a clause as there are to not customize a clause. As explained above, the standard clause relies heavily on the advocates and a thoughtful, experienced arbitrator to collaboratively create a custom process in real time. This successfully occurs frequently. Sometimes, however, parameters cannot easily be agreed to while in the thick of the dispute, or agreeable counsel may settle on a process that mirrors the courtroom (both of which can be costly and time consuming), leaving clients with sour memories and raising serious questions about inserting an ADR provision into future contracts.

Thus, the crafting begins with well intentioned, battled-scarred mindsets like, “Don’t ever let that happen again,” “It can’t take longer than 90 days,” “We need three arbitrators next time,” “Make them come to us,” “What if . . . tried this,” and “I heard from a friend that we want to include . . . .”

In most cases, customizing a clause can help streamline the dispute resolution process. However, there are times when a custom clause becomes confusing, overly burdensome, or is impossible to interpret and administer. The courts and administrative agencies are regularly faced with arbitration clauses that are problematic in some respect. Resolving ambiguous filing requirements, vague conditions precedent, or unrealistic deadlines can add to costs and delays when parties in a dispute must work with a poorly worded dispute resolution clause. “Caveat Emptor” or “What’s Good for the Goose . . .” are phrases to remember when discussing what should and/or should not be included in your next dispute resolution clause.

So Many Choices

There are many resources available to the reader when choosing options. The AAA has “developed a ClauseBuilder® online tool—a simple, self-guided process—to assist individuals and organizations in developing clear and effective arbitration and mediation agreements.” Organizations such as JAMS offer drafting guides that help avoid ambiguity when contemplating the various choices in customizing an ADR clause.

Additionally, and specifically for M&A transactions, the Business Law Section of the American Bar Association offers the Model Asset Purchase Agreement and the Model Stock Purchase Agreement with Commentary, which are available as resources for attorneys negotiating and documenting a deal. These publications include model language, commentary, and explanations of related substantive laws regarding many issues. ADR clauses and purchase price dispute resolution clauses in M&A agreements are also covered.

Many parties use a standard clause as their “foundation” and then modify it to address unique circumstances, increase process predictability, or attempt to produce a desired outcome within the process. Items that can be included in the ADR clause are:

Domestic/International Rules

Number of Arbitrators

Method of Arbitrator Selection

Arbitrator(s) Qualifications

Locale Provisions

Governing Law

Discovery

E-Discovery

Documents-Only Hearing

Duration of Arbitration Proceedings

Remedies

Forum Fees and Attorney’s Fees

Opinion Accompanying the Award

Confidentiality

Language

Nonpayment of Arbitration Expenses

Appellate Process

Although this list is long, and each item seems like a great idea to consider, the list does not include the myriad ways in which the language surrounding the concept can become lengthy and confusing to the advocates and arbitrator(s) who are bound by the ADR clause. Language can be misinterpreted, and disputes may not arise until years after the documents are signed. It is therefore important to be clear and concise where possible, but remain flexible enough to allow administrators, advocates, and arbitrators the ability to adapt quickly and adjudicate the case in an efficient manner. It is realistic to recognize that you cannot, more times than not, design the perfect ADR mousetrap. In addition, what might work (or has worked) for certain disputes in certain parts of the world may not work in others. The general goal to include an ADR clause in any contract is to create a process that is fair and effective in resolving disputes in a manner that provides all the benefits of ADR: confidentiality, efficiency, some level of autonomy in selecting mutually agreeable mediators and arbitrators, and (hopefully) a reduction of legal costs in comparison to litigation.

International Considerations

Choice of the Seat. Although the selected arbitrators are probably the single most important factor in any arbitration, in an international arbitration, the “choice of the seat” of the arbitration may be a close second. The seat (as opposed to the location(s) of the hearings) is the jurisdiction of law that governs the arbitration. The courts of the seat, applying the procedural law of the arbitration (lex arbitri), supervise the arbitration for issues ranging from determining the validity of the arbitration agreement, compelling the parties to conform to the arbitration agreement, regulating the appointment of arbitrators, handling challenges should the parties or a chosen arbitration organization fail to do so, and deciding an action to set aside an award.

The procedural law, as applied by the courts of the seat, determines to what extent the courts can and cannot interfere in the arbitration. This is different from the substantive law applied to the transaction itself. In fact, there may be multiple substantive laws involved in an international transaction (e.g., contract law, real property law, labor law, etc.).

Although it is possible to choose a seat in one jurisdiction and the procedural law of the arbitration of a separate jurisdiction, it is almost always advisable for the courts of the seat to apply their own law. Thus, the arbitration clause should clearly identify both the seat and the procedural law. For instance, the Hong Kong International Arbitration Centre (HKIAC) model clause suggests the following:

“The law of this arbitration clause shall be . . . (Hong Kong law).

The seat of arbitration shall be ... (Hong Kong).”

For choosing the seat, the Chartered Institute of Arbitrators (CIArb) in London has developed a set of principles “to provide a balanced and independent basis for the assessment of existing seats and to encourage the development of new seats.”

The CIArb London Centenary Principles (or London principles) comprise of 10 elements:

  • an arbitration law providing a good framework for the process, limiting court intervention, and striking the right balance between confidentiality and transparency;
  • an independent, competent, and efficient judiciary;
  • an independent, competent legal profession with expertise in international arbitration;
  • a sound legal education system; the right to choose one’s legal representative, local or foreign;
  • ready access to the country for witnesses and counsel and a safe environment for participants and their documents;
  • good logistical support, including transcription, hearing rooms, document handling, and translation;
  • professional norms embracing a diversity of legal and cultural traditions, and ethical principles governing arbitrators and counsel;
  • well-functioning venues for hearings and other meetings;
  • adherence to treaties for the recognition and enforcement of foreign awards and arbitration agreements; and
  • immunity for arbitrators from civil liability for anything done or omitted to be done in good faith as an arbitrator.

Ad Hoc Versus Administered Arbitration. Unless the parties have experience in arbitration and can maintain a reasonable working relationship throughout the dispute, it is usually advisable to use an established arbitration organization to administer the arbitration. Not only does this free the arbitrators from the administrative tasks (such as collecting deposits and managing document flow), but it may also lend credibility to the award in the event it must be enforced in other jurisdictions, particularly those with less experience in arbitration. Ad hoc or unadministered arbitration only works if the parties and their counsel are working collaboratively toward a resolution, post-dispute.

Discovery. In polite terms, it could be said that the rest of the world is less than enchanted with U.S.-style discovery. Any attempt to include extensive discovery provisions in an international arbitration agreement is likely to be strongly resisted. The International Bar Association (IBA) has issued “Rules on the Taking of Evidence in International Arbitration,” which are a compromise between the common law and civil law approaches to the exchange of information. Although not binding rules, international arbitrators commonly refer to them for guidance even if not specified or agreed to by the parties.

Although the standard of these rules is much more restrictive than U.S. discovery (e.g., for a document to be produced, it must be “relevant to the case and material to its outcome”), note that civil law arbitrators are likely to give an even more restrictive interpretation of these rules than common law arbitrators.

Language. Finally, selecting the language of the proceedings is highly advisable. Likewise, it is advisable that all the arbitrators are fluent in that language and that relevant documents are available or produced in that language.

Sample Problem Clauses

“The parties first agree to negotiate in good faith. If unsuccessful, the parties then agree to mediation. Should mediation fail, either party may file for arbitration.”—Although admirable, leaving the resolution of future disputes to “good faith” can lead to problems—namely, if there is no good faith between the parties or counsel, arguing about whether steps precedent to others have been satisfied could be problematic, and set the case up for a fight and undue delays at the very beginning. It is more advisable to include specific timeframes when providing a “step ADR clause” so that notice and impasse can be properly evidenced when proceeding to whatever the next phase is. An example of a better step clause:

If a dispute arises out of or relates to this contract, or the breach thereof, the parties agree first to try in good faith to settle the dispute by mediation administered by the American Arbitration Association (AAA) or JAMS under its Commercial Mediation Procedures. Within 30 days after a party requests to mediate, any party may opt out of mediation by commencing binding arbitration with the AAA or JAMS in accordance with its Commercial [or other] Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.

“Disputes may be submitted to JAMS or the AAA . . .”—Sometimes drafters prefer one set of rules or ADR administrator over another, or a particular panel over another. Although providers’ rules are similar, they are different, and the panels’ qualifications of each are generally specific to the administrator. Be mindful of which providers have specialized panels that are relevant to the disputes that will likely arise from the contract, and how ADR providers’ rules differ.

“Three Arbitrators shall be appointed.”—To prevent the “lone ranger” or “rogue arbitrator,” parties will sometimes include a mandatory appointment of three arbitrators to preside over their arbitration, believing that three heads are better than one. Unless this language specifically defines a threshold amount in controversy that requires the appointment of three arbitrators, however, a small, less complicated case could become very expensive very quickly, unless the parties agree to waive this requirement. If an established ADR provider is named in the clause, some will have thresholds for amounts in controversy to determine how many arbitrators will be appointed (e.g., for the AAA, controversies with over $1 million in dispute shall result in the appointment of three arbitrators unless the contract provides otherwise or the parties agree post-dispute to proceed with a single arbitrator).

“Arbitrator must be a lawyer with 15 years of experience in the technology industry and must have a Master's degree in electrical engineering, and has been an Arbitrator for at least 10 years.”—This likely came about because, in the last arbitration, the arbitrator had no substantive knowledge in the subject matter, or the “deal” was so specific that these qualifications seemed reasonable at the time. Good luck trying to find someone who has this combination and is also available! One benefit of an administered process is help with arbitrator selection, either through their own rosters, outside organizations, or a facilitated compromise to reach an acceptable exception to this overly narrow requirement.

“The parties agree to apply the Federal Rules of Civil Procedure . . .”—Overly broad discovery can easily take over an otherwise efficient process without skilled counsel and a strong arbitrator. Language included in the clause can prevent efficiency from the start. Language added such as “or at the arbitrator’s discretion” can curtail and control the scope of discovery controversies. Most rules give the arbitrator broad discretion in allowing or limiting discovery and have a rule similar to AAA Rule 22(a), which instructs the panel to manage discovery “with a view to achieving an efficient and economical resolution of the dispute . . . .” JAMS’s Comprehensive Arbitration Rule 17, governing the exchange of information, outlines the scope and deadline for parties to engage in the voluntary and informal exchange of documents, but allows the arbitrator to “modify these obligations at the Preliminary Conference.”

“Either party may elect to appeal matters of . . .”—What may sound like a good idea to protect against a “bad decision” can drive up cost and time. Arbitration is inherently final and binding. Although some providers do offer rules for limited appeals (e.g., both AAA and JAMS offer an optional arbitration appeal procedure) in recognition that clients may hesitate to agree to arbitration due to its limited grounds for overturning an award, one of the hallmark benefits of arbitration is its finality; adding an appeals process should only be included if absolutely necessary. The cost and time associated with appealing the arbitration (within the confines of the optional arbitration appeals process offered by some ADR providers and not in the courts) makes sense in only a few “bet the farm” scenarios.

An example case of a good idea gone wrong is Hall Street Associates v. Mattel Inc. (2008), where an atypical clause in an arbitration agreement stipulated that the district court could override the arbitrator’s decision if “the arbitrator’s conclusions of law are erroneous.” Under the arbitration agreement in that case, both parties agreed to resolve matters according to Federal Arbitration Act (FAA) procedures; however, the FAA had a specific list of categories to which a court could override an arbitration award (e.g., “corruption,” “fraud, “evident partiality,” “misconduct”). Cost and time did indeed increase for this dispute: the initial arbitration in favor of Mattel was reviewed by the district court, the district court found legally erroneous conclusions, the arbitrator then ruled for Hall Street (the district court affirmed), the award was appealed to the U.S. Court of Appeals for the Ninth Circuit (in favor of Mattel), and finally the U.S. Supreme Court granted certiorari. The Supreme Court affirmed (6-3) the Ninth Circuit and held that the FAA’s categories are exclusive and cannot be expanded through contractual agreement.

Conclusion

The inclusion of an ADR clause in financial, M&A, and joint venture deals is increasingly favored because it offers parties confidentiality, expediency, ability to control the selection of decision makers in future disputes, the choice to craft a dispute resolution process that makes sense for all parties who wish to avoid the vagaries and unpredictable delays of the courts in both domestic and international jurisdictions, among other myriad benefits when compared to litigation. A savvy transactional attorney who understands the nuances of when it makes sense to include a step clause (where mediation is either encouraged or required) and when to modify a clause to address a specific concern or desire of their clients has great control to mitigate exposure and possibly reduce the time and cost associated with litigation - but only if the ADR clause is drafted thoughtfully, carefully, and in consultation with an experienced litigator who shares the clients’ interests and understands their concerns and goals. Recognizing that negotiating the dispute resolution clause can have a negative impact during the formation of a new venture or a merger, the hope is that the drafters take time to understand the process of mediation and arbitration (in contrast to litigation) and how customizing an ADR clause can be greatly beneficial (or very detrimental if drafted poorly), and to consider all the resources available to craft a dispute resolution process that their clients will appreciate should the deal go south in the future.


Editing assistance provided by Edgar Gonzalez.


 

ABOUT THE AUTHORS

Garden City, NY

Leslie Ann Berkoff

Leslie A. Berkoff is a Partner with Moritt Hock & Hamroff LLP where she serves as Chair of the firm’s Bankruptcy Practice Group, as well as Advisory Co-Chair of the firm’s Diversity & Inclusion…

Andrew Barton

Andrew Barton heads up the AAA® San Antonio Regional Office focusing on the AAA’s Commercial Division.

In that role, he interacts with the AAA’s clients who…

Serena K. Lee

Serena K. Lee is the General Manager for the San Francisco and Santa Rosa resolution centers for JAMS, Inc.  A frequent lecturer and instructor on alternative dispute resolution processes, Serena has…

Peter R. Day

Peter R. Day is the principal of Mercer Island Arbitration Chambers International, LLC, and is a Fellow and Approved Faculty member of the Chartered Institute of Arbitrators in London.  He has considerable…

Susan Tomaine

Susan Tomaine, a Partner at Blakes, advises public and private companies with respect to mergers and acquisitions and corporate finance transactions, as well as on general corporate matters and compliance…

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