I ti Alteriiativr.\ CPR Institute for Dispute Kezolutioii V d . 14, No. 2 Frhi-uav 1996

ADR Clauses Must Anticipate Contingencies By Jarril F. Kaplan Sometimes a poorly drafted predispute arbitration agreement winds up thwart- ing the parties’ intent. That’swhat hap- pened in two recent court of appeals cases, both involving securities fraud.

The first case involved Peter Kostan- tacos, who opened a customer account with Piper,Jaffray & Hopwood, Inc. and signed one of the company’s standard “Fiduciary Cash Accounts” agree- ments. I t required arbitration of all controversies “in accordance with the rules then in effect of the Arbitration Committee of the New York Stock Ex- change or the National Association of Securities Dealers.”

When Mr. Kostantacos filed a securi- ties fraud class action against Piper and others, Piper responded with a motion to compel arbitration. Soon after, the NASD amended its Code ofArbitration Procedure to prohibit NASD members from seeking to enforce any arbitration agreement against a customer who has initiated a class action against the bro-

Jnrnl E Kaplnn is Of Counsel to Snell & Wilmerin Phoenix, and n member of thejirm % izDR Committee.

ker-dealer. SEC approval made the amendment effective “for all open ar- bitrations and for arbitration filings made on or after that date.”

Unfortunately, the parties had incor- porated not only the NASD rule, but also any subsequent amendments, into their agreement. The net effect, then, was to prohibit arbitration-exactly the opposite of what Piper intended by including a predispute arbitration clause in its standard agreement.

Therefore, the district court denied the motion to compel arbitration. The court of appeals affirmed Sept. 19, Konstantaros 71. Piper, 665 F.3d 145 (7th Cir. 1995). As a result, the class action landed in court, rather than in arbitra- tion. A simple qualifier in the “rules then in effect” clause (perhaps “except to the extent inconsistent with arbitra- tion”) would have prevented that result.

A similar error came to light in a high-profile shareholders’ derivative suit. Defendants in this suit were ex- Salomon Brothers officials who had signed agreements providing for arbi- tration of any disputes arising out of their employment “in accordance with the [NYSE] Constitution and rules.”

Three years after suit was filed, the defendants belatedly remembered the arbitration clause and moved to com- pel arbitration before the NEE.

The district court granted their mo- tion, but the NkSE declined to arbitrate, invoking its discretion to “decline in any case to permit the use of [its] arbitra- tion facilities.” The exSalomon officials then moved for an order compelling arbitration and for the court to appoint substitute arbitrators, but the district court denied their motion.

In affirming the district court deci- sion, the court of appeals held Oct. 13 that when the parties select a specific forum for arbitration, that is the only place a court can order them to arbi- trate. Neither §5 of the Federal Arbi- tration Act nor any other law permits the court to select a substitute arbitral forum where the exclusive forum selec- tion term has failed, In re Salomon Znc., U S . App. LEXIS 28830 (2d Cir. 1995).

Lesson for drafters: arbitration clauses should contain alternative methods offorum selection in case the forum becomes unavailable or the fo- rum selected becomes unwilling or unable to serve. !m

States Struggle to Govern Use of Mandatory Arbitration ~~

(continued from front page) state efforts to curb mandatory arbi- tration. In Dobson, the Court held that the Federal Arbitration Act preempted an Alabama statute barring predispute arbitration agreements. The purpose of the FAA was to overcome “judicial hostility” to arbitration among state courts, the court said.

After Dobson, what power do states retain? The Montana Supreme Court rejected the argument that Dobson robbed states of all authority to regu- late arbitration agreements in interstate commercial contracts, Casarotto u. Lombardi, No. 93-488 (Aug. 31, 1995). The court had reached the same con- clusion in 1994, but the U.S. Supreme Court vacated the Montana court’s original ruling last June and directed the court to reconsider the case in light of Dohon.

At issue was a franchise agreement between Paul and Pamela Casarotto and Doctor’s Associates Inc., the Con- necticut-based corporation that owns Subway Sandwich Shops. The Casarot- tos brought breach and fraud claims against Doctor’s Associates and its Montana agent, Nick Lombardi. The franchisor sought to stay the action under an arbitration clause in the fran- chise agreement. Montana’s Supreme Court held that the agreement violated a state law requiring clear notice on the front page of any contract that con- tained an arbitration clause.

After the U.S. Supreme Court re- manded the case, a divided Montana court declined the high Court’s obvi- ous invitation to overrule its earlier decision. “We can find nothing in the Dobson decision which relates to the issues.. . in this case,” wrote Justice

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Terry N. Triewiler for the majority. Specifically, the court found that-

even after Dobson-the FAA preempts state laws only to the extent that they prevent parties from knowingly agree- ing to arbitrate. The Alabama statute at issue in Dobson made written arbi- tration agreements invalid and unen- forceable. The Montana law, in contrast, “simply requires that the par- ties be adequately informed of what they are doing before they enter into an arbitration agreement,” Justice Triewiler wrote. This requirement “does not undermine the goals and policies of the FAA.”

In a strong dissent, Justice Karla M. Gray argued for a broader reading of Dobson. The Supreme Court expressly stated that the purpose of the FAA is to “overcome courts’ refusal to enforce (continued on following page)