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Arbi-trouble?

Arbitration.  Arbitrary.  Arbitrable. Arbi-trouble?  With the rising popularity and utilization of Alternative Dispute Resolution (“ADR”), parties to contracts often turn to arbitration provisions to govern contractual disputes. In certain transactions, parties may find it more efficient and less costly to agree to arbitrate specific, non-legal disputes arising from the transaction while leaving broader contractual disputes to the courts.  More and more, we see non-lawyer, non-judges – such as accountants, financial services advisors, engineers, physicians, etc. – serving as arbitrators for certain disputes related to their area of expertise.

For example, two parties entering into an asset purchase agreement (“APA”) for the sale of a business and the APA contains an earn-out provision.  The APA contains a general dispute resolution provision placing jurisdiction over disputes arising from the APA in federal court in Tennessee.  However, also contained in the APA, is  an arbitration provision that dictates an accountant shall arbitrate disputes regarding certain calculations provided for in the APA, specifically the closing balance sheet and the earn-out calculations.  After the sale, and during the earn-out period, disputes arise as to the manner in which the acquiring company is operating the business.  The seller initiates arbitration, relying on the accounting arbitration provision, but asserts claims for breach of the covenant of good faith and fair dealing.  What is arbitrable by the Accountant-Arbitrator?

The burden rests on courts to determine whether the parties intended to arbitrate breach of contract claims not involving accounting issues before an accountant arbitrator.  Solvay Pharmaceuticals, Inc. v. Duramed Pharmaceuticals Inc., 442 F.3d 471, 477 (6th Cir. 2006). (“In fact, absent ‘clear and unmistakable’ evidence that contracting parties intended an arbitrator (rather than a court) to resolve questions of arbitrability, courts should independently decide whether an arbitration panel has jurisdiction over the merits of any particular dispute”) (internal citations omitted).  Where there is not a clear referral of all disputes to arbitration, “courts are not to twist the language of the contract to achieve a result which is favored by federal policy but contrary to the intent of the parties.”  Paladino v. Avnet Computer Techs., Inc., 134 F.3d 1054, 1057 (11th Cir. 1998).  The general rules favoring arbitration do not apply with the same force in this situation as they do in a case with a more broadly applicable provision:

A longstanding principle of this Circuit is that no matter how strong the federal policy favors arbitration, arbitration is a matter of contract between the parties, and one cannot be required to submit to arbitration a dispute which it has not agreed to submit to arbitration.  This Court has drawn a clear line between the extensive applicability of general arbitration provisions and the more narrow applicability of arbitration clauses tied to specific disputes.  When faced with a broad arbitration clause, such as one covering any dispute arising out of an agreement, a court should follow the presumption of arbitration and resolve doubts in favor of arbitration…  However, when an arbitration clause by its terms extends only to a specific type of dispute, then a court cannot require arbitration on claims that are not included.

Twin City Monorail, Inc. v. Robbins & Myers, Inc., 728 F.2d 1069, 1072 (8th Cir. 1984) (internal citations omitted.)

The Sixth Circuit considered a case similar to the example presented above in which a business was sold under an asset purchase agreement that contained an accountant arbitration clause governing disputes relating to “any of the amounts included in the Closing Balance Sheet” of the transaction.  Bratt Enterprises, Inc. v. Noble Int’l Ltd., 338 F.3d 609, 611-13 (6th Cir. 2003).  The parties had numerous disputes regarding the accounting of the parties’ final balance sheet and the seller filed suit.  The buyer filed a counterclaim alleging that the seller had breached its post-closing obligations and had miscontrued the parties’ agreement.  Id.  Because the breach of contract claim by buyer was related to the balance sheet dispute, the district court ordered arbitration on the breach of contract claim in addition to the dispute over the actual accounts payable balance.  Id.  The Sixth Circuit reversed, holding that:

[w]hile Noble’s claim would obviously require reference to the closing balance sheet to determine matters of valuation should Noble prevail on this issue, the dispute regarding the validity of the [$1.2 million] limitation provision does not itself involve a “disagree[ment] with any of the amounts included in the Closing Balance Sheet.” …Thus, this aspect of Noble’s breach of contract claim is not within the scope of the arbitration clause and is, therefore, not arbitrable.

Id. at 613.  Nor was the result altered by the fact that ordering arbitration on the dispute over the proper amount of accounts payable and refusing to order arbitration on the breach of contract claim resulted in “piecemeal litigation.” Id. at 613.  See also, Solvay Pharmaceuticals, Inc. 442 F.3d at 478 (Courts are entitled to “engage in a functional inquiry.  They may ask whether the parties would have thought the particular limitation best adjudicated by a panel of industry experts, or rather whether more searching judicial review would likely have been preferable.”)

Ultimately, the overwhelming majority of courts when analyzing broad accountant dispute resolution provisions have found that breach of contract allegations exceed the functional scope of the applicable accountant arbitration provisions.  Despite this favorable case law, it is in the best interest of parties wishing to utilize a hybrid dispute resolution model to carefully draft language that specifies the jurisdiction of the arbitrator and clearly defines what disputes are arbitrable and what disputes aren’t.  This should keep you out of arbi-trouble.

Taylor B. Mayes