March 1, 1995

FINANCIAL SERVICES NEWSLETTER 

IS IT TIME TO JUMP ON THE ARBITRATION BANDWAGON?

By now many of you are aware of the recent United States Supreme Court case that rejected Alabama's strong anti-arbitration policies. As a result of the ruling in Allied-Bruce Terminix Companies, Inc. v. G. Michael Dobson, et al, 115 S. Ct. 834 (1995), the test in Alabama for the enforceability of a contract provision requiring arbitration no longer is whether the parties actually contemplated substantial interstate activity, but rather the test is whether the transaction is one "involving commerce." Because the term "commerce" (meaning interstate commerce) is interpreted quite broadly, most agreements to which a financial institution is a party will be deemed contracts "involving commerce."

Now that arbitration provisions will be more readily enforceable, in consumer as well as commercial situations (the Allied-Bruce Terminix case involved a suit by a consumer against a national pest control company), financial institutions and other commercial organizations need to determine whether arbitration better suits their needs than litigation, and, if so, in what instances.

I. Why Arbitrate?

Arbitration generally leads to a quicker resolution of a dispute at a much reduced cost. The speed results from a combination of the limited discovery available in arbitration and being able to avoid the backlog of a court docket. The same factors also contribute to the reduced cost of an arbitration proceeding. Another obvious benefit of the arbitration process is that it can take a potentially inflammatory lawsuit away from a jury.

II. When To Arbitrate.

Disputes submitted to commercial arbitration generally involve the factual issue of whether one or both parties may have breached a contract. Arbitration may not be appropriate in all disputes involving commercial transactions, such as a simple suit on a debt. If the parties agree in a contract that all disputes arising out of the contract shall be submitted to arbitration, the parties may be forced to arbitrate a simple claim on a promissory note. A claim on a note or another debt due, assuming no defenses are asserted, most likely would be more efficiently resolved through the judicial process. This concern may be addressed in arbitration clauses by permitting the lender to maintain a suit on the debt, but stating that if a counterclaim or other factual claim is raised in defense, all matters (including the claim on the debt) will be submitted to arbitration.

Arbitration provisions likewise should exclude self-help remedies, such as repossession and foreclosure, from their terms so that the secured creditor will retain the right to exercise those remedies. As simple as this statement may seem, an all-encompassing arbitration clause, which requires that every dispute be submitted to arbitration, may pretermit the exercise of other legal remedies and require the creditor to obtain the approval of an arbitrator prior to exercising its right of self-help repossession and foreclosure.

One document in which financial institutions should consider including an arbitration provision is the commercial loan or lease commitment letter. Many facts that may arise or come to the lender's attention during the due diligence stage may cause a lender to cancel the commitment in accordance with its insecurity or other due diligence provisions. The potential lender liability claim resulting from the failure to fund the loan is the only likely dispute to arise out of a commitment letter, and is the most common form of lender liability claim. An arbitration provision can prevent this claim from being tried in front of a jury.

III. What About Consumer Contracts?

Arbitration provisions in consumer relationships, including deposit accounts as well as loan or lease transactions, also should be enforceable under the Allied-Bruce Terminix case. An arbitration clause should prevent breach of contract and fraud claims from going to court, but will not be able to defeat a court's jurisdiction of certain statutory claims, such as claims made under the Truth in Lending Act.

IV. Are Jury Waivers Still A Good Idea?

A waiver of jury trial should be enforceable in most commercial transactions. Under Alabama law, jury waivers are enforceable if they are conspicuous, bargained for and are between parties that are not of greatly disparate bargaining power. The clauses thus would not normally be enforceable in boilerplate consumer contracts.

The jury waiver may be more favorable than arbitration in some contracts. Since most disputes over a commercial loan transaction will involve a claim on the debt, the waiver of jury trial would ensure that any potential counterclaim will be decided by a judge sitting without a jury, thus significantly lessening the potential for punitive damages. Commercial lenders may want to include an arbitration provision in the commitment letter, and have that provision be superseded by a waiver of jury trial in the closing documents. This would permit a lender liability claim rising from an alleged breach of the commitment to be submitted to arbitration, and permit a suit on the debt, and any counterclaims by the borrower for lender liability or other matters, to be tried by a judge sitting without a jury.

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Of course, the content of any arbitration clause is extremely important, as it will determine the instances in which arbitration will occur and the rules that will be applied. Careful thought thus should be exercised in deciding whether to include an arbitration provision in a particular document, as well as the specific content of that clause. Arbitration is a hot topic among financial institutions in Alabama right now. The purpose of this newsletter is not to expound on every aspect of arbitration and the decision of whether it is better to arbitrate or litigate, but rather to point out that some caution should be taken when determining which types of potential disputes are best suited for arbitration.