The Limits of Mandatory Arbitration Clauses

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By Anthony Minchella
| Litigation

Limits of Mandatory Arbitration

Mandatory arbitration clauses have become an increasingly popular topic among contract and litigation attorneys. The reviews are mixed, though, given the perceived benefits and often prohibitive limitations. Mandatory arbitration forces parties to the underlying agreement to resolve disputes privately with a third-party arbitrator, rather than in court with a judge or jury. Proponents applaud the benefits of arbitration as less costly and more procedurally flexible. Critics argue that they unduly benefit the party with more bargaining power, and therefore should not be upheld.

According to the International Chamber of Commerce (ICC), a majority of international contracts between large corporations now include mandatory arbitration clauses. That said, we’ve seen noticeable pushback on the clauses in the past few years, especially in the context of agreements that involve a relatively large corporate entity on one side and an individual on the other, such as an employee or consumer. New Jersey courts are leading the charge, as recent cases in that state have refused to enforce mandatory arbitration clauses in consumer and employment contracts.  

When two companies decide that it is in their best interest to arbitrate, arbitration becomes a win-win option. The same cannot always be said of arbitrations involving less legally sophisticated parties.

When Are Mandatory Arbitration Clauses Invalid?

There are three types of contracts where mandatory arbitration clauses may be invalid.

  1. Consumer Financial Services Agreements: As of May 5th, the Consumer Financial Protection Bureau has proposed a rule that would prohibit mandatory arbitration clauses in financial services agreements that limit access to class action lawsuits. Once formalized, this rule would apply to all contracts, including those already signed. Although such a rule would not necessarily prohibit mandatory arbitration for single-plaintiff claims, arbitration clauses that do not specifically exclude class action lawsuits from their reach may be invalid regardless.

  2. Consumer Contracts: Although generally upheld, mandatory arbitration clauses in consumer contracts are non-binding when there is evidence of fraud. The Theranos lawsuits have recently brought this reality back to the attention of corporate lawyers. Because Theranos and Walgreens face accusations of widespread fraud, otherwise enforceable arbitration clauses are thrown out, allowing for class-action claims regardless. It’s important to note that these cases demonstrate that the fraud must merely be investigated, not conclusively proven, for the courts to now invalidate arbitration clauses.

  3. Employment Contracts: The National Labor Relations Board has been throwing out arbitration clauses in employment contracts for over a year, but these decisions are now upheld by federal appeals courts. On May 26th, the 7th U.S. Circuit Court of Appeals declared mandatory arbitration clauses as a condition of employment to be a violation of federal labor law that impeded the right to concerted efforts protected by the National Labor Relations Act. As it currently stands, all employment contracts containing mandatory arbitration clauses can be considered non-binding.

While courts may not always invalidate mandatory arbitration provisions in these types of contracts, companies will find that such clauses can be severely limited. Furthermore, recent rules by the FTC and other government organizations indicate that mandatory arbitration clauses may be further limited in consumer contracts in the future. The SEC is even currently investigating the use of mandatory arbitration clauses in shareholder agreements and may limit their use quite soon.

Companies are advised to keep an eye on these developments and always consult a sophisticated and experienced lawyer before relying heavily on an arbitration clause in their contracts.

 

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