Liz Kramer | Stinson Leonard Street LLP | August 3, 2016
What is “arbitration”? Although courts often use and apply the word, rarely do they stop to define it. While the FAA concerns agreements to “settle by arbitration a controversy,” the FAA does not define “arbitration,” leaving the question to the courts. Lacking definitive guidance from the U.S. Supreme Court, two lines of cases have developed among the U.S. Courts of Appeals.
The split can be traced back to AMF Inc. v. Brunswick Corp., where bowling lane companies agreed to submit disputes about advertising to a third party to determine whether the claims in the ads were supported. 621 F. Supp. 456 (E.D.N.Y. 1985). After ads from Brunswick claimed “high tech” superiority over AMF’s wooden lanes, the court set out to resolve whether the process detailed in the agreement was “arbitration.” The key language from the case is that the “essence of arbitration” is “to have third parties decide disputes.” The court concluded that the parties had agreed to arbitrate because at least one controversy — the factual issue of whether the advertising claim was supported — would be “settled.” “Arbitration” need not end all controversy between the parties, and with the factual dispute resolved it was “highly likely” that the litigation based on that factual dispute would also be resolved.
Will it resolve the dispute?
The first line of case law stemming from AMF emphasizes the likelihood of parties to resolve their disputes through a given dispute resolution process. The Third, Ninth, Fourth, Tenth, and Second Circuits take this view, each with their own twist. In Harrison v. Nissan Motor Corp. in U.S.A., the Third Circuit narrowed the AMF holding slightly, reviewing an arbitration provision that expired after 40 days and holding that the process agreed to was not arbitration because the parties did not agree to see the dispute “through to completion.” 111 F.3d 343 (3d Cir. 1997).
The Ninth Circuit expanded Harrison’s definition in Wolsey, Ltd. v. Foodmaker, Inc., 144 F.3d 1205 (9th Cir. 1998), holding that an agreement that did not “explicitly permit one of the parties to seek recourse to the courts” was still arbitration, even though it was non-binding. The Fourth Circuit stretched Harrison’s definition even further in United States v. Bankers Ins. Co., holding that an agreement that permitted a federal agency to unilaterally reject a third party’s determination qualified as arbitration. 245 F.3d 315 (4th Cir. 2001). The court reasoned that because the agency would presumably approve an arbitration award it found favorable, the dispute resolution process would not be a “futile exercise.”
Seemingly rejecting the more expansive views of the Ninth and Fourth Circuits, the Tenth Circuit held that an agreement to accept a series of appraisals to resolve a purchase price dispute was not an agreement to arbitrate in Salt Lake Tribune Publ’g Co., LLC v. Mgmt. Planning, Inc., 390 F.3d 684 (10th Cir. 2004). Relying heavily on Harrison, the court found that the appraisal at issue would only fix the purchase price under certain circumstances, and therefore would “not necessarily settle a dispute” between the parties. The Second Circuit took a similar approach in Bakoss v. Certain Underwriters at Lloyds of London Issuing Certificate No. 0510135, emphasizing precedent requiring a binding resolution for arbitration, and holding that a doctor’s “final and binding” evaluation of a disability diagnosis met the definition. 707 F.3d 140 (2d Cir. 2013).
Does it look like “classic” arbitration?
The second line of AMF-derived cases focuses less on a dispute resolution process’s likelihood of settling disputes, and instead looks for a set of procedural features indicative of “classical arbitration.” In Fit Tech, Inc. v. Bally Total Fitness Holding Corp., the First Circuit identified several “common incidents of arbitration,” including a binding resolution, an independent adjudicator, substantive standards, and an opportunity for each side to present its case. 374 F.3d 1 (1st Cir. 2004). Finding that the parties’ dispute resolution process had all of these features, at least with respect to some of their disputes, the court held that it qualified as arbitration.
The Eleventh Circuit identified the circuit split on the definition of arbitration, but did not see a real disagreement. Advanced Bodycare Sols., LLC v. Thione Int’l, Inc., 524 F.3d 1235 (11th Cir. 2008). The court concluded that submitting a dispute to a third party for a binding decision is “quintessential classic arbitration,” and identified four factors used to decide whether a dispute resolution method is arbitration, expanding on the “common incidents of arbitration.”
The Sixth Circuit provided the most comprehensive definition of arbitration of all the AMF-derived appellate cases in Evanston Ins. Co. v. Cogswell Properties, LLC, 683 F.3d 684 (6th Cir. 2012). In building its definition of arbitration, the court cited Fit Tech factors in support of the proposition that the definition of arbitration depends on “how closely it resembles classic arbitration.” The court observed that a central feature of classic arbitration is a third party empowered to render a decision settling the dispute between parties, mirroring the reconciliation approach taken in Advanced Bodycare. CitingHarrison, the court also observed that arbitration requires parties to submit to the process “through to completion.”
Why does this matter?
Many contracts provide that some third party will decide a dispute between the parties. For example, a third party appraiser will determine if a change in rent is fair, or a CPA will determine the buy-out price for a departing shareholder. But, if those provisions are treated as arbitration by the court, that means they can be strictly enforced pursuant to Section 2 of the FAA, and it means the third party’s decision is entitled to great deference, pursuant to Section 10 of the FAA. That may not have been what the parties intended when they were drafting.