When Arbitration Agreements Are Unenforceable: Common Exceptions

Arbitration Agreements Explained

Arbitration agreements are written contracts in which two parties agree to settle their legal claims in a private forum, outside of the public court system. The Federal Arbitration Act (FAA) governs arbitration agreements and is meant to encourage settlement of disputes. For the most part, when one of the parties to the contract signs the agreement, they are agreeing that if any of their legal claims arises out of the contract, those claims are to be resolved through binding arbitration. The parties only come before a judge to ask if the arbitration agreement is enforceable and if so , the judge assigns an arbitrator whose ruling is binding on the parties.
Courts generally favor arbitration agreements because they are a more cost-effective and quicker way to resolve a dispute than litigation. Depending on what kind of case the parties have, however, such arbitration agreements may not always be enforceable. While courts will generally enforce properly executed arbitration agreements, there are certain exceptions to this general rule.

Legal Basis for Invalidation

The main legal grounds upon which an arbitration agreement may be considered not to be binding on the parties are its uncertainty or that it is not supported by consideration. An arbitration agreement may be void for uncertainty if it does not identify the subject matter to which the arbitration relates. A void arbitration agreement is as unenforceable as a void contract, and considered to have no effect. An arbitration agreement may be said to be uncertain if it does not clearly set out the right to arbitration. For example, a dispute must be arbitrated pursuant to an arbitration agreement with the person with whom the parties agreed to arbitrate such dispute. An arbitration agreement must also clearly set out the procedure or mode of arbitration to be adopted.
In a "battle of forms" scenario, the question of whether an arbitration agreement is certain will turn on the interpretation of the arbitration provisions in the different forms. If a dispute falls within the scope of both arbitration clauses, there will be an agreement with certainty. If clauses conflict, the court will determine what the parties agreed to.
A statutory regime will not for the most part be considered in determining whether an arbitration agreement is void for lack of consideration. However, even among arbitrations conducted in terms of a statutory regime, the consideration issue may be raised, even though the statutory arbitrator is immune from civil liability. In addition, given that the consideration for the statutory right to arbitration is the statutory right to arbitration, it is arguable that consideration is provided whenever parties agree to arbitrate under a statutory regime. Instead, the real question is whether the consideration is adequate. In other words, the adequacy of the consideration will not be questioned.
Therefore, just because statute authorizes the right to arbitration, the courts will not interfere. The courts will not set aside the arbitration agreement between the parties by determining that there was no consideration in the absence of any other ground of illegality. Although, the courts will still interfere where the arbitration clause in itself is contrary to public policy. Or if the legislation itself ousts the jurisdiction of the courts to determine disputes between parties.

Fraud and Misrepresentation

Claims of fraud and misrepresentation are another context where an arbitration agreement might not be enforceable against an aggrieved party. The rationale behind this exception is that arbitration more closely resembles "a proprietary form of civil trial," and the parties should thus be held to the same standards as any other court proceeding.
In proving such a claim, the question is not necessarily whether the fraud or misrepresentation induced the contract, but rather whether the party seeking to vacate the contract has proven the misrepresentation or fraud as a matter of law. For example, in Nussbaum v. Diversified Consultants, Inc., the plaintiff brought a class action against the defendant arising out of plaintiff’s cellular phone bill. The plaintiff alleged fraud and misrepresentation, which precluded the arbitration provision in their contract. The defendant argued that the plaintiff failed to allege the fraud and misrepresentation with the requisite particularity under Federal Rule of Civil Procedure 9(b).
Federally, Rule 9(b) requires a party to plead fraud and misrepresentation with particularity, stating "a party must state with particularity the circumstances constituting fraud or mistake[.]" To do so, a party must allege the time, place, and substance of the allegedly false representation, and identify the person making the material misrepresentation. If the plaintiff alleges a fraudulent omission instead of an affirmative misrepresentation, the plaintiff "must specifically allege how and in what respect [the defendant] omitted to state a material fact." The Nussbaum Court found that the Plaintiff specifically stated when their bills were "miscalculated," the date and manner in which he became aware of the miscalculation, and the "manner in which [his] bills were calculated" and thus met the standard under Rule 9(b).

Conflict with Public Policy

An arbitration agreement may not be enforceable if the agreement to arbitrate is contrary to public policy, even if the Federal Arbitration Act (FAA) or analogous state legislation would otherwise have preempted state contract law that would have rendered the contract unenforceable. Such instances, however, are rare, since generally, "states may not decide they do not like a particular law for policy reasons and therefore create their own [state law]." Most state and federal courts which have addressed this issue have concluded that the weight of authority favors enforcing arbitration agreements, even ones that might contravene a significant public policy, although in such circumstances, courts and arbitrators must apply the arbitration agreement somewhat narrowly so as to avoid contravening public policy. Where the threshold question of the enforceability of an arbitration agreement is reached, courts will typically invalidate the arbitration agreement only if there is a finding of a palpable and sufficient moral, social, or economic interest that would make it improper, unlawful, or inequitable to enforce the arbitration agreement. The courts will weigh the state’s public policies and the strong federal policy favoring arbitration to ensure that they do not find a conflict between the two.

Lack of Authority

For example, a person who has been declared insane or has otherwise been found to be incompetent of an understanding to enter into a contract has also been found by courts to lack legal capacity. If a person cannot form an understanding of what he or she is doing, then that person cannot contract to arbitrate any dispute. A child, by definition, is legally incapable of entering into a valid contract. Thus, any arbitration agreement entered into by a minor may be invalid and unenforceable.

Inequitable Bargaining and Undue Influence

In the context of a career, voluntary movement between jobs is often viewed as a hallmark of success. Movement into voluntary arbitration, however, commonly calls that success into question. When employers rely on mandatory arbitration agreements for new employees or existing employees up for renewal the choice to enter into an arbitration contract is typically one of absolute necessity. The consideration for an employment agreement is employment itself. Employees often have no or little choice but to sign the employment or arbitration contract they are presented with. In these cases arbitration agreements may be found to be unconscionable and, therefore, unenforceable. Coercion of this type is typically based on the existed inequality of bargaining power between an employer and employee.
Coercion of a different type, however, can be equally as effective in foiling the enforcement of an arbitration agreement. Undue influence is a more subtle way of coercing someone into doing that which they do not want to do . Undue influence involves using excess enthusiasm, pressure, harassment and other tactics to get one who is less resistive to agree to enter into a contract. For example, some employers have sought to pressure an employee into entering into an arbitration agreement by indicating that if they do not sign the document they will not be hired, their salary will be decreased or that they will not be promoted. Some employers will suggest that the arbitration language is just a standard clause that everyone else signs so the proposed employee need not worry about it. Employers may try to convince proposed employees that the company will not hire them without signing the arbitration agreement, that the arbitration agreement does not change anything and that they are making the decision for their own good. These tactics are designed to get an employee to agree to enter into an arbitration agreement where they would otherwise decline. These tactics force one who is less resistive to agree to enter into an arbitration agreement they would otherwise have avoided.

Ambiguity and Lack of Clarity

It is settled law that if the terms of the arbitration agreement are ambiguous or vague, a court will not try to re-write the contract to make it clear or complete. In other words, an arbitration clause that appears to be ambiguous on its face or a clause that fails to address a material or major issue, such as the scope of the arbitration, does not create a binding obligation on either party. "[A] court cannot make a new contract for the parties which they did not themselves make." Rice v. Branigar Organization, Inc., 38 F.3d 153, 155 (4th Cir.1994) (citing Pannill v. Paramont Coal Co., Inc., 552 F.2d 216, 218 (4th Cir.1977); Tarris v. Bessey Corp., 309 F.2d 649, 653-54 (4th Cir.1962)). If a contractual ambiguity exists in the arbitration clause, however, the court will refer the issue to the arbitrator to resolve. "If the parties to an arbitration agreement have committed an unresolved issue of contract interpretation to the arbitrator, then the court will not interfere." Brock v. Entergy Arkansas, Inc., 129 F.3d 240, 242 (5th Cir.1997). "When the arbitrator has the task of construing the contract, an arbitrator may well determine that the contract imposes a duty to arbitrate a dispute … which a court might refuse to do." Citibank, N.A. v. Drake Ctr. Assocs., 844 F.Supp. 1177, 1182 (S.D.Tex.1993). The United States Supreme Court has held: "[A]mbiguities in an arbitration provision [are] to be resolved by an arbitrator, rather than a court … [and] a court should dismiss a case where the resolution of the dispute depends on whether or not the arbitration provision is broad enough to encompass the dispute. . . . Courts should not assume the task of forcing arbitration of issues that the parties have not agreed to arbitrate." United Steelworkers of Am. v. Warrior & Gulf Co., 363 U.S. 574, 582-85 (1960). (Internal citations omitted).

Failure to Conform to Specific Statutes

The non-compliance with specific regulations can also stand in the way of the enforcement of arbitration agreements and/or arbitration clauses. Some areas of industry are subject to specific rules on arbitration that, if violated, will result in the nullity of the clause.
For example, literary and artistic property rights are specifically excluded from the scope of French arbitration rules. Therefore, any arbitration clause purporting to submit to arbitration disputes arising under an intellectual property license would be held unenforceable by French courts. Similarly, gambling and betting disputes, as well as disputes related to tenancies, familial relations, labor disputes and patent issues, are also expressly excluded from arbitration in France.
Slightly more complex is the implication of "mandatory" court proceedings, which in certain cases may require recourse to the courts in the state where the asset or subject matter of the dispute is located. This is often the case in public policy and administrative law matters, for instance.
In addition, agreements containing harsh or lopsided clauses aimed at or impacting an individual party may not be enforced by courts if deemed contrary to public policy. Article L. 442-1 of the French Commercial Code establishes that, notwithstanding any contractual stipulation, in the case of a bilateral contract, "abusive" terms and clauses that create a significant imbalance between the rights and obligations of the parties will not be enforceable before the French courts. Such an expansive definition has been deemed to cover arbitration agreements, since they also impact the rights of the parties as to the choice of the arbitral seat and determining the governing law. Unless an agreement is reached in advance and outside of any form of pressure or coercion, the agreement appointing a specific arbitration center (as opposed to a neutral, ad hoc arbitral institution) may amount to an abusive clause, in particular in cases where similar institutions compete with one another.
Under Articles L. 442-6 and L. 442-7 of the same Code, the following elements are understood to be "abusive": a) abuse of a dominant position, b) exoneration from liability, c) joint and several liability, d) exclusion from collective proceedings, e) payment term penalties, and f) optional acceptance of amendments to the agreement. In addition, Article L. 442-2 of the same Code excludes any provision relating to unfair competition and the nationalization of employees or agents. Thus, in French courts, the validity of an arbitration clause will be tested against the contents of Articles L. 440-1 to L. 445-2.

Illustrative Case Law

When Arbitration Agreements Are Not Enforceable: Key Exceptions
One area where arbitration agreements are ruled unenforceable is when they impose excessive burdens of time or expense. In Bank Julius Baer & Co. Ltd. v. TSE (2002) O.J. No. 327, the Ontario Superior Court of Justice held because involves "a single disputed issue of law," i.e., the enforceability of an arbitration clause, it would be "a great waste of the resources of [the] parties and of the Court" to refer the matter "to an arbitral process designed for more complex issues." The Court also noted that the clause’s reference to Swiss law created "significant problems" for a court without knowledge of that jurisdiction.
Another situation where an arbitration may be refused is when there is no hope for reconciling the dispute. This was the case in King Street (U.S.) Capital Corp. v. Tetons of Colorado, Inc. [2001] 35 C.C.E.L. (3d) 223. J.A. MacDonald J. found that given the starkly conflicting accounts of the facts by each corporate party, "there cannot be any attempt at mediation and no reasonable prospect of compromise" and the action could not be referred to arbitration. The Federal Court of Appeal, however, reversed this decision on the basis that the parties had previously submitted the matter to an American arbitration tribunal, indicating their significant effort "to resolve their differences" and leaving no reason "to believe that a real attempt at prior mediation had been made."
Arbitration clauses are often read narrowly. In Ontario, this can lead to difficulties when the "subject matter of the litigation is a tort action between two Canadian insurance companies involving parties to a contract whereby the scope of insurance coverage and the determination of factual issues will be litigated, not arbitrated": Continental Insurance Co. v. Juhasz [1999] 44 C.C.E.L. (2d) 242, 39 C.P.C. (4th) 410. In other jurisdictions, the approach has been a more liberal assessment. For instance, the United States’ Federal Arbitration Act in Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967), before a court can refuse to enforce an arbitration agreement under §4 of the Act, the dispute must concern whether a contract containing such an arbitration provision was induced by fraud, as opposed to the question of whether any agreement is fraudulently induced.

Common-Sense Tips for Valid Agreements

Assuming a valid arbitration agreement, a court may order arbitration of a lawsuit any time before entry of judgment on the award, if a party so applies and the court determines. 9 U.S.C. § 3 (emphasis added). In the employment context, as discussed above, many courts have acknowledged that the primary question is equitable relief, not injunctive relief: upon the application of one of the parties to any of the parties, who is injured by such act in violation of the arbitration agreement, a judge of competent jurisdiction shall issue a final order directing the parties to obey the agreement. 164 M.L.R. 19 (internal quotation marks omitted). This interpretation of the Act is supported by the fact that injunctive relief is normally granted only to prevent future harm that is serious and imminent, not to provide redress for an existing injury that has already occurred. 164 M.L.R. 59 (quoting In re Merrill Lynch Trust Co. FSB, 235 F.3d 130, 134 (2d Cir. 2000)); see also Masco Corp. v. Zurich Am. Ins. Co., 382 F. App’x 573, 574 (6th Cir. 2010) ("An injunction ordering Masco to submit to arbitration would not preserve the status quo, because the status quo is that Masco chose not to submit the dispute to arbitration.").
While there are generally accepted best practices for drafting enforceable arbitration agreements in the first instance, these best practices may not necessarily result in an enforceable agreement, depending upon the specific facts of the case. For example, the United States Supreme Court set forth in EEOC v. Waffle House, Inc., 534 U.S. 279 (2002) the accepted test for whether an arbitration agreement containing a delegation clause was valid: First, the party seeks to invalidate an arbitration agreement [that] appears on its face to be within the coverage of the [Federal] Arbitration Act, [29 U.S.C.] § 1 et seq. (1994 ed., Supp. IV). The party contends that Congress intended by [Civil Rights Act of 1964 (Title VII), 42 U.S.C. § 1981a(b)(1)](1994 ed. and Supp . IV) (or any other federal statute) to override the [Federal] Arbitration Act so that the claim is not subject to the agreement . . . . The party therefore asserts that the court should refrain from enforcing the [Federal] Arbitration Act. Because such an agreement is unenforceable if Congress has prohibited the arbitration of the statutory claims at issue, the court is to evaluate Congressional intent in order to determine whether enforcement of the agreement is consistent with the statutory scheme.
In general, however, the following practical tips may assist in efforts to draft and maintain enforceable arbitration agreements.

Confidence The arbitration agreement, like any other contract, should be free from ambiguity and clear and unequivocal. This is usually accomplished through careful review by an attorney.
Clarity The agreement should clearly set forth that arbitration will be done in accordance with the Federal Arbitration Act, even for state law claims. The agreement should also describe the arbitrator’s role in the proceedings, including that the arbitrator will make sure that the arbitration proceeds efficiently and expeditiously.
Reasonable arbitration rules The arbitration agreement should clearly set forth the procedure that will be followed and include the following: (a) the number of arbitrators, (b) how arbitrators will be chosen, (c) how long the arbitration will last, (d) how the discovery process will work, (e) that there will be hearing, and (f) how the arbitrator will be compensated.
Scope of claims Specifically include language in the arbitration agreement setting forth that all claims, including statutory, common law, or otherwise, may be submitted to arbitration. Also, reference the Federal Arbitration Act. Some arbitration agreements have specific carve outs for class action claims, and even some Fair Labor Standards Act ("FLSA") claims. These types of carve outs will inevitably lead to arguments concerning whether the claims are exempt from the arbitration agreement.