Binding Arbitration: A New Timebomb for Lawyer and Client, by Arthur Xanthos Permalink
It is customary to recommend to a range of clients that they agree to binding arbitration as a mechanism to resolve future disputes under an agreement. Arbitration is often regarded as a cheaper, quicker alternative to litigation. The typical arbitration clause reads as follows: "Any dispute arising under this agreement shall be resolved by arbitration before the American Arbitration Association in New York City under the commercial arbitration rules then in effect." It is just as customary in the same agreement to choose a particular State law, e.g., New York law, to govern the resolution of future disputes. A simple version of this choice of law clause reads as follows: "This agreement shall be governed by the laws of the State of New York." ADR, alternative dispute resolution, arbitration, Arthur Xanthos, choice of law, contracts, Flintlock, Gartner + Bloom, limited liability company, operating agreement, punitive damages
Yesterday, the New York State Appellate Division, First Department, had the opportunity to consider a case involving an agreement containing both clauses. A limited liability company's operating agreement contained both an arbitration clause and a choice of law (New York) clause. But the commercial arbitration rules (mandated by the arbitration clause) conflicted with New York State law (mandated by the choice of law clause) in one important respect: commercial arbitration rules permit an arbitrator under some circumstances to assess punitive damages against a party to the arbitration. New York State law, on the other hand, does not permit an arbitrator to assess punitive damages. So when an agreement contains both clauses (commercial arbitration rules, and New York State choice of law), may an arbitrator award punitive damages?
Yes, said the Appellate Division in a sharply divided 3-2 decision. Matter of Flintlock Constr. Servs. LLC v. Weiss, 2014 NY Slip Op 05818 (8/14/2014). The majority held that the operating agreement's choice of law provision, in the absence of additional limiting language, "is insufficient to remove the issue of punitive damages from the arbitrator".
The Flintlock decision is problematic for two reasons: First, what do contracting parties do about their already executed agreements that now have conflicting clauses? It is barely overstatement to say that the overwhelming majority of shareholder agreements, operating agreements, asset sale agreements, and even employment agreements contain both of these clauses. Second, how should such agreements be drafted going forward? Pending an appeal of the Flintlock decision, attorneys should follow the First Department's direction and place limits on the arbitrator's power to impose punitive damages. The new clauses might read as follows:
"ARBITRATION. Any dispute arising under this agreement shall be resolved by arbitration before the [NAME OF ARBITRATION TRIBUNAL] in [LOCATION]. The arbitration shall be conducted under commercial arbitration rules then in effect, but the arbitrator(s) shall resolve the dispute in accordance with the laws of the State of New York without giving effect to principles of conflict of laws. The arbitrator(s) shall have the limitations on his, her and their power and authority as are found in New York State law, including without limitation no power or authority to award or assess punitive damages."
"CHOICE OF LAW. This agreement, its validity, construction, and enforcement, shall be governed by the laws of the State of New York, without giving effect to principles of conflict of laws."