Arbitration clauses are standard across all industries, from commercial agreements to employment contracts. However, choosing arbitration under the Federal Arbitration Act (FAA) can present unique legal challenges that could impact your case, particularly if third-party discovery is involved.
What to Know About Section 7 of the FAA: The Third-Party Discovery Hurdle
One of the most significant issues clients run into with the FAA arises from Section 7, which governs subpoenas for third-party discovery. Many people don’t realize that under the FAA, you cannot engage in the type of traditional discovery against third parties that is regularly used in litigation, such as subpoenaing documents or conducting a deposition. Additionally, FAA arbitration can create a jurisdictional quagmire that drives up expenses and complicates the case, particularly where the third party is out of state and the information the party holds is critical.
Real-World Implications for Arbitration Agreements
It’s important to understand these implications when drafting or signing arbitration agreements, and you should carefully evaluate your goals and consider the potential for third-party involvement before including a clause that mandates federal arbitration. Here are three critical factors to keep in mind:
- Whether to Mandate State or Federal Arbitration
The FAA is nearly a century old and was designed to increase efficiency while limiting the burden on third parties. As such, its outdated framework can hamper modern arbitration proceedings. Mandating arbitration governed by state arbitration acts might be a better choice if you anticipate needing third-party discovery—but the decision is complicated. Certain states, such as Washington, restrict the use of mandatory arbitration in specific contexts. Understanding your jurisdiction’s laws is crucial, as it will affect whether arbitration is even a viable option for certain disputes. It may also make sense to avoid arbitration altogether.
- Discovery Needs
If your case is likely to involve significant third-party discovery, the limitations of Section 7 under the FAA could stymie or complicate your efforts. Thirty-five states have adopted versions of the Uniform Arbitration Act, which may provide greater flexibility and more robust pre-hearing discovery than the FAA. Moreover, this area of federal law is riddled with circuit splits and unresolved questions, allowing the litigious third party to drastically hamper your arbitration and drive up costs.
- Deciding Between Mandatory Arbitration or Litigation
Arbitration isn’t a one-size-fits-all solution. The nature of your business, the likelihood that you may face litigation, and the types of potential litigation that could arise all make a big difference in whether arbitration or traditional court litigation makes sense for you. It’s important to consult with legal counsel and think through the scope of your arbitration clause and how it aligns with your dispute resolution goals. For example, in trade secrets cases, a mandatory arbitration clause might prevent you from taking action against third parties, such as new employers who receive stolen information. For further analysis about arbitration vs. litigation, click here.
Arbitration clauses shouldn’t be an automatic addition to every contract. Instead, commerical contracts require careful planning and strategic foresight. Before simply inserting mandatory arbitration language, it’s wise to consider your industry, the likelihood of third-party involvement, and the governing rules. Consulting a litigator who understands the unique challenges of the FAA will go a long way toward anticipating and protecting against these types of problems. If you have questions or need additional counsel on this topic, please contact me.
