Supreme Court says parties can't contract around the arbitration rules

Tuesday, the U.S. Supreme Court issued a much awaited decision concerning arbitration agreements. Hall Street Associates LLC v. Mattel Inc. Full Opinion in PDF format While this case won't grab many headlines and is unlikely to be featured on the evening news, arbitration agreements are very common in high-tech, which means that changes to this area of the law can have far reaching effects.

Arbitration clauses are popular for several reasons: (1) they dictate where a future case will be heard, (2) they remove the risks of trying the case to a jury, (3) they lessen exposure to class action lawsuits, and (4) they tend to favor businesses rather than consumers. PayPal, eBay, and many other software and on-line service providers include arbitration clauses in their standard terms of use, as do airlines, cruise ships, and outdoor arenas (though there is some question concerning the enforceablity of arbitration provisions in one-sided contracts such as software "shrink-wrap" licenseswikipedia:"shrink wrap contract"). They are also frequently used in intellectual property license agreements. But there's a catch. The federal statute governing arbitration, the Federal Arbitration Act ("FAA"), also "makes contracts to arbitrate "valid, irrevocable, and enforceable,' so long as their subject involves 'commerce.'" Id. at 5. Specifically, unless you can prove the arbitration involved corruption, fraud, misconduct, exceeding authority, or evident miscalculation of the award, the courts cannot overturn an arbitration decision. See FAA Sec. 10, 11. In other words, once an arbitration decision is made, you're stuck with it.

To make arbitration a bit more flexible, lawyers often wrote the terms of the contract to expand judicial oversight of the process. In the Hall Street case, the arbitration agreement gave the court power to change any arbitration award if the arbitration panel made a legal error, giving the disappointed party what amounts to a do-over in Federal Court. The exact wording of their agreement was as follows:

"[t]he United States District Court for the District of Oregon may enter judgment upon any award, either by confirming the award or by vacating, modifying or correcting the award. The Court shall vacate, modify or correct any award: (i) where the arbitrator's findings of facts are not supported by substantial evidence, or (ii) where the arbitrator's conclusions of law are erroneous."

In other words, the parties agreed to make the binding arbitration a little less binding. Until this week, federal courts in eighteen states allowed this practice, courts in twenty-two states rejected it. Numerous organizations filed friend of the court briefs in support of one side or the other, some arguing the importance of finality in arbitrations, others predicting doom and gloom for arbitration if the courts were not allowed more oversight. Now the matter is settled. The wording of the statute governs, and parties can not obtain heightened judicial review by writing their arbitration agreement to allow it. In other words, absent a few narrow exceptions, you're stuck with the arbitrator's decision.

This doesn't mean that the parties cannot protect themselves from arbitrators who ignore the law. Arbitration agreements can, and often do, include requirements that specify the rules and procedures that must be followed. My prediction is that going forward, arbitration provisions will become a bit more detailed as to the legal procedures that must be followed, giving parties and their lawyers a few more things to argue about when drafting a contract.