Drafting arbitration provisions for high-tech deals

Arbitration provisions have become a staple of high-tech contracts in recent years, and mostly for good reason: Arbitration can -- if done right -- be a speedy, cost-effective and private alternative to a lengthy and unpredictable state or federal court proceeding. Arbitration often includes streamlined discovery procedures, which can deliver cost savings to the parties, and arbitrators can also bring subject-matter expertise well beyond what a typical jury or judge would have. For example, the parties can select arbitrators with experience in particular legal areas (e.g., patent law, trade secret law or international contract disputes), technical areas (e.g., semiconductor manufacturing or pharmaceuticals), or life experiences (e.g., former judges or engineers). At its best, arbitration provides quick, cost-efficient, and well-reasoned results.

In practice, however, procedural pitfalls can plague an arbitration, and unexpected costs can trip up the unwary. Compared to federal or state courts, arbitration authorities typically have very few procedural rules. This means that parties to an arbitration often find themselves in uncharted territory. In addition, decisions made by arbitration authorities are typically unpublished. Because there is little authority to rely on, procedural issues in arbitrations can be complicated to brief and outcomes may be uncertain.

Luckily, crafting the right arbitration provision up front can allow you to minimize procedural issues and ensure that your arbitrator has the correct subject-matter expertise. In this article, we set out a few practical pointers that contract negotiators and drafters can use to ensure that, if arbitration becomes necessary, your company can obtain a just, speedy and cost-effective resolution.

What arbitration institution and venue should you choose?

There are a number of arbitration institutions to choose from, including JAMS, the American Arbitration Association (AAA), and the International Chamber of Commerce. Different institutions have different areas of subject-matter expertise -- and that expertise often varies by location.

Companies often wisely take the time and make the effort in their agreements to designate that arbitration will take place in a particular locale. San Francisco or the Bay Area, for instance, is a common choice, perhaps with the goal of saving on travel costs (for companies that are located in the Bay Area or desire a United States location convenient to Asia) and/or with the goal of drawing from a sophisticated pool of tech-savvy arbitrators.

If contractual arbitration provisions do not also specify a particular procedure for choosing an arbitrator, however, the parties to a future dispute will be left with the default arbitrator selection process of the organization that is arbitrating. That process typically involves the parties describing their ideal qualifications, the organization selecting candidates from its roster that (hopefully) meet the parties' criteria, and then the parties ranking or striking the options provided. If no agreement can be reached (for example, if the candidates do not have the requested qualifications or if one or both sides strike most candidates), new lists are often provided, restarting the process and delaying the progress of the arbitration.

When reviewing arbitrator lists for the different arbitration organizations in a particular locale, one quickly discovers that not all arbitrator lists are created equal. JAMS in the Bay Area, for example, has a large number of former federal judges and also many technical adjudicators from which to select. Other Bay Area lists have a surprisingly limited number of adjudicators with semiconductor or computing backgrounds, although not all organizations make their lists public, perhaps because doing so would highlight any such shortcomings.

In one recent arbitration involving such an organization, we were surprised to discover that, after requesting arbitrators with intellectual property and semiconductor experience, we instead received a list of former realtors with real property experience, which is hardly the same thing. This inevitably led to objections and striking of names, prompting the organization to send new lists and causing a delay. Those new lists had acceptable candidates that the parties selected, but not any located in the Bay Area. That type of solution to a weak arbitrator list (i.e., flying in arbitrators from other locations) increases costs because most arbitrators require payment not just for travel expenses, but also for travel time. In other words, if you want arbitrators with particular subject-matter expertise, keep in mind that it all depends on the arbitration organization's roster. Do not assume, for example, that the availability of tech-savvy arbitrators will be a given just because you are holding your arbitration in Silicon Valley.

It is worth noting that the AAA has a specialized panel for disputes related to aerospace, aviation, defense, cyber and security, which could be appealing for the right types of technology companies. Likewise, the AAA has specialized patent rules, although they do not apply (absent agreement) to the types of contract disputes that are more frequently subject to arbitration (e.g., indemnity disputes about underlying patent litigations). Those rules also cannot bridge the gap if the arbitrator(s) do not have patent law expertise in the first place.

In light of these facts, when selecting the private arbitration group that will preside over the arbitration, there are a number of things that should be considered, including the venue desired, the strengths of the arbitration group's rosters in that venue, and whether some of the thrash of selecting from an unknown (or known) roster list can be mitigated by contractually agreeing to a selection process that does not tie the parties to a particular organization's roster. For instance, the parties can agree that they can each select any neutral arbitrator (regardless of whether such arbitrator appears on a particular arbitration organization's roster) or one side can provide a list of names from which the other can select. It is generally a bad idea, however, to simply choose a particular organization without doing one's homework first.

How many arbitrators do you need?

In recent years, many companies have opted for a three-arbitrator panel, either selected pursuant to the arbitration organization's rules or through some other mechanism by the parties. Regardless, there are some important considerations to take into account if three arbitrators are desired.

The most important of these considerations is cost. Having three arbitrators, each of whom is most likely paid by the hour, necessarily at least triples the cost of the arbitrator fees. Indeed, in many cases, it will more than triple that cost because the arbitrators will spend additional time conferring that would not have been necessary if there had been just one arbitrator. Even though these fees are typically (though not always, depending on the agreement) split between the parties, they will rack up quickly. Hourly arbitrator rates rival those of outside counsel, and the mere fact of using a three-arbitrator panel can, by itself, eviscerate much of the cost savings that the contracting parties anticipated when they chose to arbitrate in the first place.

We therefore suggest that parties consider whether a single arbitrator will suit their needs equally well. That being said, it is of course possible with a single arbitrator to get an outlier who reaches extreme or incorrect decisions (decisions that are difficult to get reviewed), and the presence of three arbitrators provides a check against this possibility.

Will you need to join multiple parties?

Surprisingly, many arbitration authorities do not have clear-cut rules that define when additional parties can be joined. This can result in delay and expense when attempting to join parties. Consider inserting language directly into your arbitration provision that will explain what additional parties can be joined in a single arbitration and under what circumstances.

In some cases, it is fairly easy to predict in advance whether arbitration will be necessary against multiple parties. For example, if a company requires all of its suppliers to indemnify it for intellectual property disputes, it is possible that a patent suit will implicate indemnity considerations for multiple suppliers. In this situation, you are best served by bringing a single arbitration against multiple suppliers. Including a joinder provision into your agreement can provide multiple benefits:

• It can save you the time and expense of litigating joinder in the arbitration;

• Efficiencies of scale may be achieved from bringing a single arbitration rather than multiple arbitrations that may be tried on different schedules or under different rules (see "What rules should apply?" below); and/or

• Trying claims against multiple parties at once can eliminate the risk of them "pointing the finger" at each other and systematically underpaying; it maximizes the chances that you will be fully compensated.

What rules should apply?

Many arbitration provisions simply say that the rules of a particular arbitration authority should apply. For example, a provision might specify that arbitration may be conducted "by the American Arbitration Association under its Rules." But this may not be specific enough. For example, the AAA has Commercial Rules, International Rules, Construction Rules and several other mutually-exclusive rule sets that can govern an arbitration. The existence of different rule sets can create confusion. For example, in a commercial dispute that involves both a foreign supplier and its U.S. subsidiary, do the Commercial Rules or the International Rules apply? Confusion on the applicable rule set can add time and expense. You are generally much better served by agreeing to a set of rules (and supplemental area-specific rules, if applicable) up front.

When selecting the rule set that best suits your needs, take into account the scope of discovery that you will require and either provide for that discovery specifically in your arbitration provision or choose rules that are consistent with your anticipated needs. For example, the AAA's Commercial Rules contemplate that some expert discovery may be required and that the parties may exchange expert reports, while the International Rules do not contain any provisions for party-selected experts. The Commercial Rules also provide the arbitrator with broad discretion to order discovery in large cases and allow the parties to take depositions upon a showing of good cause, while the International Rules generally do not allow depositions, interrogatories, or requests for admission. High-tech cases in particular often require expert testimony and significant fact discovery, such as depositions of engineers or other technical witnesses. If you contemplate relying on such discovery, make sure your rule set allows it.

Arbitration can be an efficient (and private) way to resolve disputes. By considering procedural issues up front, contract drafters can ensure that their companies can resolve their disputes in a fair, efficient, and cost-effective manner.