June 30, 2020 Practice Points

Considering Fraud and Arbitrability While Drafting Arbitration Clauses Can Save Litigation Headaches

Distractions can be minimized with careful wording of a clause that makes it unmistakable that all disputes under a contract are to be arbitrated.

By Jeremy Heep and Sam Harrison

Arbitration-averse plaintiffs sometimes seek to bypass a contractual arbitration by filing a lawsuit that alleges fraud and hoping a court will rule that the fraud claim falls outside the scope of the arbitration clause. It is a challenging strategy on which to prevail, particularly considering recent Supreme Court precedent giving more teeth to a parties’ ability to delegate these scope issues (also known as “arbitrability” issues) to the arbitrator. Nevertheless, for defendants interested in preserving arbitration’s principal aims, lengthy pit stops in court to argue about whether an arbitration clause covers fraud can undermine the reasons to arbitrate in the first place (allowing the parties to control venue, forum, procedure, privacy, cost, and time to resolution for a dispute). These distractions can be minimized with careful wording of an arbitration clause that makes it unmistakable that all disputes under a contract (including the scope of the arbitration clause itself) are to be arbitrated.

For defendants seeking to arbitrate, the U.S. Supreme Court has diminished federal courts’ powers to resolve threshold issues that relate to whether a particular claim (i.e., fraud) is covered by an arbitration clause. In Henry Schein, Inc. v. Archer & White Sales, Inc., the Court recently rejected an exception that had arisen in lower courts that permitted courts to adjudicate a potentially arbitrable claim when the court determined the defendant’s argument to refer the case to arbitration was “wholly groundless.” 139 S. Ct. 524, 529 (2019). In striking down the exception, the Court summarized its holding: “When the parties’ contract delegates the arbitrability question to an arbitrator, a court may not override the contract. In those circumstances, a court possesses no power to decide the arbitrability issue.” Id. Nevertheless, the Court retained the requirement that, for arbitrability to be delegated to the arbitrator, this delegation must be shown by “clear and unmistakable evidence.” Id. at 530.

While Henry Schein provides a strong tool for defendants to prevent a district court from inquiring into whether a claim is subject to arbitration beyond determining whether a valid agreement to arbitrate exists, plaintiffs still may seek to have the case first examined by a court, claiming that fraud claims are not subject to arbitration. (See, e.g., Totten v. R.G. Constr., No. C 02-04599 JSW, 2005 U.S. Dist. LEXIS 38816, at *10 (N.D. Cal. Dec. 13, 2005). Even after the Supreme Court’s ruling, the ability of a court to determine fraud claims that surround an arbitration provision is still being litigated. See Crypto Asset Fund, LLC v. MedCredits, Inc., No. 19cv1869-LAB (MDD), 2020 U.S. Dist. LEXIS 55951, at *11 (S.D. Cal. Mar. 30, 2020). The Crypto Asset Fund court ultimately sent the case to arbitration based on Henry Schein, explaining there was “little doubt valid arbitration agreements exist here[.]” Id. As to the plaintiffs’ claims of fraud, the Court explained, “Because Plaintiffs’ arguments concerning fraud and unconscionability go to the validity of the contract as a whole the arbitrator should consider those arguments in the first instance.” Id. at *17.) The strongest medicine to prevent this detour from arbitration is an arbitration clause that clearly covers all claims “arising out of or related to” the contract and, better yet, specifically identifies arbitrability as an issue reserved for the arbitrator.

Fortunately, most arbitration institutions provide sample arbitration clauses that provide this kind of tested language the parties can use to shortcut discussions about workshopping an arbitration provision. For instance, the International Chamber of Commerce’s sample clause reads:

All disputes arising out of or in connection with the present contract shall be finally settled under the Rules of Arbitration of the International Chamber of Commerce by one or more arbitrators appointed in accordance with the said Rules.

The phrase “arising out of or in connection with the present contract” is broad language that likely prevents a plaintiff from claiming the scope of the arbitration clause would not include fraud. Generally speaking, including “arising out of or relating to” or similar language is interpreted as a “broad” arbitration clause by courts. Dlorah, Inc. v. KLE Constr., LLC, No. 16-5102-JLV, 2017 U.S. Dist. LEXIS 110435, at *9 (D.S.D. July 17, 2017) (citing Fleet Tire Serv. of N. Little Rock v. Oliver Rubber Co., 118 F.3d 619, 620-21 (8th Cir. 1997)). Moreover, the ICC’s rules specifically reserve any questions of arbitrability or scope for the arbitral panel. See generally Petrofac, Inc. v. DynMcDermott Petro. Operations Co., 687 F.3d 671, 675 (5th Cir. 2012) (“We agree with most of our sister circuits that the express adoption of [rules that reserve arbitrability for the arbitrator] presents clear and unmistakable evidence that the parties agreed to arbitrate arbitrability.”). JAMS’ clause goes even further and specifically mentions that it covers arbitrability disputes:

Any dispute, claim or controversy arising out of or relating to this Agreement or the breach, termination, enforcement, interpretation or validity thereof, including the determination of the scope or applicability of this agreement to arbitrate, shall be determined by arbitration in [insert the desired place of arbitration] before [one/three] arbitrator(s). The arbitration shall be administered by JAMS pursuant to its Comprehensive Arbitration Rules and Procedures [and in accordance with the Expedited Procedures in those Rules] [or pursuant to JAMS' Streamlined Arbitration Rules and Procedures]. Judgment on the Award may be entered in any court having jurisdiction. This clause shall not preclude parties from seeking provisional remedies in aid of arbitration from a court of appropriate jurisdiction.

(emphasis added). Given the provision’s requirement that disputes regarding arbitrability be referred to the arbitrator, the JAMS provision does well to meet the “clear and unmistakable” requirement of Henry Schein. Parties should consider including such explicit language in their arbitration clauses.

There is no certain way to prevent a plaintiff from filing a case that should be arbitrated in court first. A plaintiff can claim the arbitration clause was fraudulently induced or that it is unclear the arbitrability issue was reserved for the arbitrator and ask the court to rule that the arbitration clause does not cover a particular legal theory or remedy. Nevertheless, by making the arbitration clause precise and clear as to arbitrability—preferably removing all doubt by using default language from the preferred arbitration entity—parties who want to protect their contractual right to arbitrate can do their best to make a plaintiff’s odds of success in court so low that they are dissuaded from testing the waters.

Jeremy Heep is a partner and Sam Harrison is an associate with Pepper Hamilton in Philadelphia, Pennsylvania.


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