Pre-Dispute Agreements to Arbitrate Come Under Fire

Since the enactment of the Federal Arbitration Act in 1925 there has been a strong federal policy in favor of arbitration absent a showing of legal or equitable grounds for revocation of the contract that includes the arbitration provisions.  Areas in which the use of arbitration provisions have often been contentious include franchise, consumer and employment contracts and franchisees, dealers, consumers and employees have often argued, largely without success, that arbitration requirements in those contracts should be avoidable on the basis of “fraud in the inducement.”  However, if the Arbitration Fairness Act of 2007, which was introduced in Congress in July 2007, becomes law, pre-dispute agreements to arbitrate statutory defined “franchise,” “consumer,” and “employment” disputes would be unenforceable.  Of note is the fact that the Arbitration Fairness Act would not only apply to agreements that went into effect after the date that the Act became effective but would also apply retroactively to contracts that had been entered into before the effective date.  The Arbitration Fairness Act would essentially re-write existing contracts and substantially alter the strategic positions of the parties in the event that a dispute covered by an arbitration clause arises.

Obviously the following definitions of the “disputes” that would be subject to the Arbitration Fairness Act are extremely important:

  • "Franchise" disputes include those arising under any contract whereby (1) a franchisee is granted the right to engage in business under a marketing plan prescribed in substantial part by the franchisor, (2) the operation of the franchisee’s business is substantially associated with a commercial symbol such as a trademark or logo, which designates the franchisor or an affiliate of the franchisor, and (3) the franchisee is required to pay a franchise fee, either directly or indirectly.
  • "Consumer" disputes include those between a "person" (which would not include an organization) and a seller or provider of property, services, money, or credit with respect to goods or services obtained for personal, family, or household purposes.  In general, a consumer dispute would not include a transaction in which goods or services are obtained for business purposes; however, small businesses could seek to invalidate an arbitration clause in cases where the contract was between "parties of unequal bargaining power."
  • "Employment" disputes include those between employees and employers using the definition of employee-employer relationship found in the Fair Labor Standards Act.  Arbitration provisions in collective bargaining agreements would not be subject to the Arbitration Fairness Act.

Another important change included in the Arbitration Fairness Act is that the courts, applying federal law, would have the authority to decide whether an arbitration provision is enforceable.  Current law generally places the issue of whether a dispute must be arbitrated in the hands of the arbitrator unless the parties have expressed a preference for a court to decide in the specific arbitration agreement.

The changes for success of the Arbitration Fairness Act are uncertain at this point; however, it is an interesting development worth watching closely.

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