Arbitrating the Patent Case Part VI: Arbitration clauses to watch out for

In the last couple of articles in this series, we looked at arbitration clauses to use in patent cases. These clauses will most likely be involved in license agreements, employee agreements, or product development agreements.  We noted that a good place to start is not simply the last arbitration clause someone in your office did, but rather the AAA Commercial Rules form clause. You will then want to add the Supplementary Patent Rules, and then state the number of arbitrators and the location of the arbitration. This should avoid most litigation over whether to arbitrate and what to arbitrate. We explored a number of other possible additions, to fine-tune the clause such as keying the number of arbitrators to the amount in dispute, stating the qualifications for an arbitrator, limiting or ensuring certain discovery and the like. We also explored some more usual possible provisions such as “baseball” provisions, where the arbitrator(s) must pick one of the Award amounts suggested by each side.

How much detail you want to put in the clause will depend primarily on whether you think it best to leave the exact process to a skilled arbitrator after you know more about the nature of the dispute, or whether you think it best to control everything you can about the process in the clause while you have a chance to do so. Reasonable minds can differ on that. I tend to be a little more in the trust-the-arbitrator camp, but it depends on the nature of the contract and the type of dispute you foresee.

There are some provisions that might seem at first like good ideas, but upon further analysis, may not be. Let’s look at a few of those.

One type of provision you may see is one that limits the arbitrator’s power to “interpreting the contract,” and not deciding any issues under any statutes, common law or other matters. This is a perhaps laudable attempt to narrow the issues, but it could have some real problems. By limiting the power of the arbitrator in that way, you may be simply setting up part of the case for arbitration and the rest for litigation. The last thing you want in terms of expense is a two-front war, so to speak.

Another provision to think long and hard about is a mandatory award of attorneys’ fees and costs. While this may seem like a good idea at the time, it can skew the arbitration. Sometimes parties have legitimate disputes that simply need to be decided by an objective third party.  If the price of doing that can be, however, paying the other side’s fees, the dispute about fees can sometime overwhelm the real issues in the case. It also creates an opportunity for the side that is sure of impending victory – whether there is reason to be sure or not – to put more resources and expense in the case since they will be sure that will be on the other parties’ dime. An alternative may be to give the arbitrator the ability – but not the mandate – to award fees to the prevailing party, trusting the arbitrator to be able to make the judgment whether the position taken by a party warrants an award of fees or not.

Another provision I have seen that raises some confusion is one that forbids the arbitrator from awarding “consequential damages.” Without a better definition, you are creating significant ambiguities. Drawing the line between direct and consequential damages is not always easy. Do consequential damages include incidental damages – which are separately defined in the U.C.C. — for example? How indirect do damages have to be to be consequential? At very least, some more definition is needed. And is it really a good idea to foreclose recovery for your client of what might be an expensive breach that causes real, albeit consequential, damages?

It is not uncommon for arbitration clauses to forbid an award of punitive or exemplary damages. Again, be careful.  While the instinct to avoid a possible punitive damages award may be justified, what if you find yourself in a situation where your client would be justified in seeking such damages? Do you want to foreclose that? The normal reason people include such clauses is to make sure the arbitrator(s) do go off-track and make a large award of punitive damages that isn’t justified. But consider that you have quite a bit of control in who is chosen as arbitrator. You can strike arbitrators you don’t have faith in, for example.  In the end you may decide this type of provision is alright, but think through it.

Another clause that I have seen allows discovery as if under the Federal Rules of Civil Procedure. I suppose whoever suggested thought they may have won their last case if only they had more discovery or were worried they wouldn’t get enough discovery. I find, however, that most people’s complaint about arbitration is that there is still too much discovery if the process is not well managed. Thus, expanding discovery to the scope of the Federal Rules strikes me as abandoning the flexibility, efficiency and cost savings of arbitration. If you are really concerned about not getting sufficient discovery, you would be better off saying the parties shall each be allowed X hours of depositions and that there will be an exchange of key relevant documents or the like. Remember, however, that the rules already give the arbitrator the power to order exchange of necessary information. You are probably best off spending your efforts picking an arbitrator you trust to properly control the discovery process than trying to micromanage discovery in a future dispute, the contours of which you can only make guesses about.

Finally, some arbitration clauses say that the Federal Rules of Evidence will apply at the hearing. I can’t imagine that is ever a good idea. Relaxation of strict evidentiary rules is an advantage of arbitration. And there isn’t any harm in it. After all, the rules of evidence are designed primarily to keep irrelevant or unreliable evidence from a lay jury. Here your fact determination is being made by a skilled arbitrator, who is generally a lawyer and quite familiar with what kind of evidence is relevant and reliable. Indeed I, like many arbitrators, often remind counsel that the rules of evidence don’t apply, but that doesn’t mean that unreliable hearsay will suddenly be useful in deciding the case. Unreliable evidence will be disregarded as, well, unreliable. Thus, the parties will want to bear in mind that the point of the rules of evidence is to assure that only reliable evidence will be used to decide the case and present evidence that conforms to the rules to make their case more persuasive. But there is little danger a skilled arbitrator will base a decision on unreliable evidence.