The arbitration clause as super contract.

• Author: Frankel, Richard
• Position: III. Overriding State Contract Law through Conclusion, with footnotes, p. 554-587

3. OVERRIDING STATE CONTRACT LAW

This Article focuses on three specific areas where courts are distorting contract law by enforcing arbitration clauses that likely would not be enforced under ordinary contract principles. First, courts have applied the federal policy favoring arbitration to interpret ambiguous arbitration agreements in favor of arbitration instead of applying the longstanding contract doctrine of interpreting ambiguity against the party that drafted the agreement. Ambiguity in arbitration clauses can occur quite often, given that such clauses are typically placed in contracts of adhesion that leave no opportunity for bargaining or amendment. The two principles often collide because, particularly in consumer and employment cases, it is the drafter of the agreement that seeks to enforce the arbitration clause against the non-drafting party. Interpreting ambiguous contracts in favor of the drafter encourages manipulative and deliberately unclear arbitration clauses that will lead individuals to waive their rights in ways that they never realized when signing the underlying contract.

Second, in addressing whether a party waived its right to enforce an arbitration clause, many (but not all) courts require a finding of prejudice to the opposing party and will refuse to find waiver in the absence of prejudice. This directly contravenes basic contract law, which establishes that waiver depends on the intent of the waiving party rather than on whether there is detrimental reliance by the opposing party. Such a rule creates bad policy by allowing parties to litigate their dispute and then subsequently turn to arbitration if it looks like they are not going to get the result they want in court.

Third, courts have relied on the federal policy favoring arbitration to give non-signatories to the agreement a greater ability to enforce the agreement and compel arbitration of a dispute than they would have for other contracts. The result has been to blur the distinction between signatories and non-signatories by giving non-signatories many of the exact same rights under the agreement as signatories. That distinction is important because, understandably, contract law treats parties to a contract very differently from parties that have no connection to it.

1. Ambiguous Contracts

   Numerous courts, at both the state and federal level, have construed the policy favoring arbitration expansively so as to override the long-standing and well-settled contract rule that ambiguities in standard-form contractual terms should be interpreted against the drafting party. (107) Known by its Latin formulation, contra proferentem, (108) this doctrine is a well-established tenet of contract law. (109) Although some authorities have said that the doctrine should be used as a "last resort" when extrinsic evidence fails to resolve the ambiguity, (110) extrinsic evidence is often unavailable in arbitration disputes, and the doctrine has been frequently applied to standard-form contracts of all types. (111)

   Courts and commentators offer several sensible rationales for the doctrine. (112) The main justification is that the rule encourages greater clarity in contracts through better drafting. If the party who drafts the contract runs the risk of losing when ambiguities arise, that party has an incentive to eliminate those ambiguities. (113) Otherwise, drafting parties have the perverse incentive to write purposefully ambiguous contracts that they can exploit to their benefit and to the detriment of the non-drafting party. (114) A second justification is that the rule operates as a "penalty default," (115) which requires the drafting party to reveal information about itself and its preferences through the inclusion of express terms rather than ambiguous ones. (116) Third, the rule can be seen as serving a fairness function. It helps correct the imbalance stemming from the rise of contracts of adhesion in which the non-drafting party typically has inferior bargaining power and little or no ability to negotiate the terms of the agreement. (117)

   Although courts apply contra proferentem to all types of standard-form contracts, they treat arbitration agreements differently. While courts have split on the question, the majority has read Moses H. Cone's policy favoring arbitration to trump the doctrine of contra proferentem and to require ambiguities to be interpreted in favor of arbitration, even if it is the drafting party that seeks to enforce the arbitration clause. (118)

   Resolving ambiguities in favor of arbitration, instead of against the drafter, can make all the difference in determining whether a party loses its access to a judicial forum. Many arbitration clauses lack clarity as to whether a particular dispute falls within the scope of a mandatory arbitration provision. (119) Those ambiguities now permit a drafting party to enforce an ambiguous arbitration clause even though, in almost every other contractual setting, the court would adopt a contrary interpretation of the contractual term. Indeed, courts often have found ambiguity to be dispositive, sending a dispute to arbitration precisely because the agreement was unclear as to whether the dispute belonged in arbitration. (120)

   The policy of interpreting ambiguities in favor of arbitration also has been applied to other challenges to the applicability of an arbitration clause. One type of challenge involves Section 5 of the FAA, which governs when a substitute arbitrator can be appointed if the arbitrator designated in the agreement becomes unavailable, or when the unavailability means that the arbitration clause becomes unenforceable. (121) This seemingly mundane question has generated a large and growing amount of litigation, as many companies draft arbitration clauses to require arbitration in front of a single arbitration provider, usually because the company believes that the provider is more likely to rule in the company's favor. One notable example involves the National Arbitration Forum (NAF), which until recently was one of the nation's leading arbitration providers and the leading provider for arbitration of debt-collection matters. (122) Many arbitration clauses require arbitration in front of NAF, and, as revealed in a lawsuit brought by the state of Minnesota, NAF was riddled with conflicts of interest that caused it to systematically favor companies over individuals in resolving arbitrations. (123) NAF settled the lawsuit by agreeing to not accept any new arbitrations or influence any of its pending arbitrations. (124) Litigation has ensued over whether clauses requiring arbitration in front of NAF can be enforced by substituting a new arbitrator.

   Although litigation in this area is still emerging, courts generally will agree to substitute a new arbitrator unless they find that the contract's designation of a specific arbitrator was "integral" to the agreement. (125) However, answering that question necessarily requires the court to make a subjective judgment, and a contract rarely will specify whether the designation of a particular arbitrator is integral. Thus, the contract will almost always be silent or ambiguous on the question, and some courts have relied on that ambiguity to permit substitution of a new arbitrator and hence enforcement of the arbitration agreement. (126)

   This extension of the federal policy favoring arbitration by lower courts is incorrect and is not compelled by Moses H. Cone. No doctrinal basis exists for overriding the general rule of contra proferentem and for sending disputes to arbitration when it is not clear that the parties agreed to arbitrate a particular dispute. Indeed, the drafters of the FAA emphasized that they intended to preserve the defense that the parties did not agree to arbitrate a particular dispute, and there is no indication that the drafters intended for the Act to place any limits or restrictions on that defense. (127)

   Nor has the Supreme Court itself always required arbitration in the presence of ambiguity. For example, the Court has held that the question of an arbitration clause's enforceability can be resolved in arbitration only when the arbitration clause contains "clear and unmistakable" language delegating that question to the arbitrator. (128) Similarly, the Court recently interpreted an arbitration agreement's silence on the availability of classwide arbitration to mean that classwide arbitration ordinarily is unauthorized, even if that leads to less arbitration as a result. (129) Thus, Moses H. Cone does not give lower courts carte blanche to ignore general contract principles regarding interpretation of ambiguous agreements.

   Moreover, overriding the rule of contra proferentem in the arbitration context makes for bad policy. First, it encourages manipulative behavior by entities that use arbitration clauses in their standard-form agreements. They have every incentive to make those clauses increasingly vague as to which disputes require arbitration, with the knowledge that if the clause is ambiguous, courts will require arbitration, even if the non-drafting party would not have reasonably anticipated that such disputes would be covered by the clause. (130)

   There appears to be some evidence, particularly in the consumer context, that companies intentionally make their arbitration clauses difficult to understand so that consumers will not fully realize what rights they are giving up. For example, an expert on readability analyzed the arbitration agreements of several payday loan companies (131) and found that (a) "the vast majority of Americans would have difficulty comprehending the [companies'] arbitration agreements," (b) a reader would require a college-level education to understand them, (c) the companies used terms that were undefined and did not appear in conventional dictionaries, and (d) the companies used sentences so long (including a 28 8-word sentence) as to render them "essentially...