When Arbitration Becomes Impossible: When are parties excused from an agreement to arbitrate?
By Jeffrey I. Ehrlich
Advocate January 2006 | Download .pdf
Does the California Arbitration Act provide a solution?
At first glance, it would seem that section 1281.6 would apply in either of the situations described above; that is, when an arbitration provider refuses to proceed, (that is, when the “agreed method fails”) or when an arbitrator fails to act. The court in Richards v. Merrill Lynch, Pierce, Fenner & Smith, Inc. (1976) 64 Cal.App.3d 899, 901-902 [135 Cal.Rptr. 26] relied on section 1281.6 after it had held that the arbitration clause at issue was unenforceable. Richards arose out of arbitration clause in a securities brokerage contract. The arbitration clause provided that the arbitration would be conducted by the NYSE, in New York, under the rules of the NYSE, which could be changed from time to time, or in reference to a particular dispute. (Id.) The trial court held that this agreement was unenforceable, and the Court of Appeal affirmed. In particular, it was concerned with the provision allowing the rules of the arbitration to be changed with reference to a particular dispute.
While the court refused to enforce the arbitration agreement as written, it did not hold that the dispute could be resolved in court. Rather, the court explained:
This [the unenforceability of the arbitration agreement] does not necessarily mean that on a proper showing Merrill Lynch would not be entitled to arbitration under more conventional auspices than the NYSE rules. Having in mind the strong policy in favor of arbitration (see Madden v. Kaiser Foundation Hospitals, 17 Cal.3d 699, 706, 131 Cal.Rptr. 882, 552 P.2d 1178), the agreement to arbitrate as such–if otherwise found to be untainted–appears to be severable from the incorporation of the NYSE rules. If the naked agreement to arbitrate is valid, and the parties cannot agree on a method of proceeding, the solution is provided by statute. (See Code Civ.Proc., ss 1281.6, 1282–1284.2.) (Id., 64 Cal.App.3d at 906.)
A decade later, another court faced with the standard arbitration clause in a securities brokerage contract reached the identical result. In Lewis v. Merrill Lynch, Pierce, Fenner & Smith, Inc. (1986) 183 Cal.App.3d 1097 [228 Cal.Rptr. 345] the court held that the arbitration clause was unconscionable and unenforceable, but relying on section 1281.6 of the Code of Civil Procedure and Richards, it directed the trial court to simply appoint a new arbitrator in the event that the parties could not come to an agreement on their own about who should arbitrate the case and what the applicable rules would be. (Id. at 1107.)
More recent decisions have taken a different approach. In Alan, the court rejected the argument that section 1281.6 would allow the trial court to appoint a new arbitrator when the NASD refused to proceed with the case. It acknowledged that this statute would apply “if the obstacle to arbitration can be resolved by the appointment of an arbitrator.” (Id., 111 Cal.App.4th at 228-229.) But it determined that the refusal of the specified arbitral forum to proceed was not equivalent to the failure of an arbitrator to act, and could not be cured by appointing a new arbitrator under section 1281.6. (Id.)
Rather, in the court’s view, the arbitration provisions would “fail in their entirety” without NASD participation, because the forum selection provisions that specified that the arbitration would be conducted by the NASD was an integral part of the arbitration agreement. (Id.) The court explained, “[A]n agreement to arbitrate before a particular forum is an integral term of a contract as any other, which courts must enforce.” (Id., at 228, citing, Wall Street Associates v. Becker, Paribas, Inc. (S.D.N.Y. 1993) 818 F.Supp. 679, 683.)
The Alan court relied heavily on In re Salomon, Inc. Shareholders Derivative Lit. (2d Cir. 1995) 68 F.3d 554. In Salomon, Inc., shareholders brought a derivative action against ex-Salomon officers, who had signed agreements providing for the arbitration before the New York Stock Exchange (“NYSE”) of any dispute arising from their employment. The defendants moved to compel arbitration before the NYSE, but the NYSE refused to hear the case, relying on a provision in its bylaws allowing it to decline to hear cases. The case returned to the district court, which refused to send the case to arbitration in another forum, and which instead set the case for trial. The defendants appealed, and the Second Circuit affirmed the district court, explaining:
Because the parties had agreed that only the NYSE could arbitrate any disputes between them [the district court] properly declined to appoint substitute arbitrators and compel arbitration in another forum. . . The arbitration agreements here required that any arbitration be before the NYSE, and not before any other arbitral forum. Accordingly, we will not disturb [the trial court’s] decision to proceed to trial.” (Salomon, Inc., 68 F.3d at 557-561, cited by Alan v. Superior Court, 111 Cal.App.4th at 226.)
Ironically, despite its holding that that arbitration agreement providing for a NASD forum was “integral,” the Alan court nevertheless stopped short of ordering the trial court to proceed with the case, as in Salomon. Rather, the court held that the NASD’s offer to hold the arbitration in a location outside of California might be sufficient, and directed the trial court to evaluate whether arbitration by the NASD was “proper” in the out-of-state forum it selected. Only if the court found that the forum was not “proper,” could the trial court refuse to enforce the arbitration agreement entirely and decide the case itself. (Id. at 230.)