Recently the United States Court of Appeals for the Fourth Circuit issued a published opinion on the topic of binding arbitration clauses in written contracts. In Noohi v. Toll Bros., Inc., 708 F. 3d 599 (4th Cir. 2013), a class action of prospective home buyers alleged that a developer unlawfully refused to return deposits when the prospective buyers could not obtain mortgage financing. The Agreement of Sale included an arbitration provision governing disputes between the parties. The home buyers sued the developer when deposits were not refunded, and the developer filed a motion to dismiss or stay the suit pending arbitration. The Federal Court denied the motion to arbitrate, finding that the arbitration clause in the Agreement of Sale lacked mutuality of consideration under Maryland law because it required only the buyer—but not the seller—to submit disputes to arbitration.
This Federal Court decision has me thinking about a common arbitration clause I frequently encounter when I review subcontract agreements. The clause I often encounter reads as follows:
Any controversy or claim between the Contractor and the Subcontractor arising out of, or related to, this Subcontract, or the breach thereof, except for those claims which have been waived by the making or acceptance of any payment, shall be settled by arbitration if the Contractor, in its sole discretion, elects to arbitrate the controversy or claim in lieu of litigation. The election to arbitrate shall be solely in the discretion of the Contractor and, if the Contractor elects to arbitrate, the Subcontractor expressly consents to arbitration which shall be conducted in the same manner and under the same procedure as provided in the Prime Contract with respect to claims between the Owner and the Contractor, except that a decision by the Architect shall not be a condition precedent to arbitration. If the Prime Contract does not provide for arbitration or fails to specify the manner and procedure for arbitration, it shall be conducted in accordance with the Construction Industry Arbitration Rules of the American Arbitration Association currently in effect unless the parties mutually agree otherwise. If the Contractor in its sole discretion elects to waive arbitration, any controversy or claim as defined herein shall be settled by formal litigation.
I have always felt that this clause can be unfair. The clause reminds me of a mantra I learned back in the days of law school: If the facts are on your side, you want to arbitrate; if the law is on your side, you want to litigate; and if neither is on your side, you want to settle. So I ask myself the question whenever I see this clause: Why would anyone allow the other party to make this decision to arbitrate? It seems to me that the clause provides an unfair advantage because the decision one way or another would be made based on the particular and specific circumstances of the underlying dispute.
Well, it seems there is merit to my concern. In Noohi, the Federal Court, applying Maryland law, held that an arbitration clause must be provided by its own separate legal consideration, i.e., consideration separate from the overall underlying contract. In layman’s terms, this means that the arbitration clause itself must contain a promise to perform a desired act or a promise to refrain from performing an act that one is legally entitled to do, i.e., an agreement by which both parties exchange mutual promises, with each promise acting as sufficient consideration for the other promise. However, the Federal Court held that the arbitration clause in Noohi bound only the home owners to arbitration and it did not operate in both directions to bind the developer. As such, the arbitration clause lacked the legal concept of mutuality of consideration, i.e., both parties were not bound to perform the obligations set forth in the arbitration clause itself. As such, the Federal Court held that neither party would be bound to the arbitration clause.
This is a concept I will think about from this point forward when I see arbitration clauses allowing the other party to elect arbitration at its sole option. Arbitration can have its benefits, but this is not always the case. I tend to strike these types of one-sided dispute resolution clauses when I review and negotiate subcontract agreements, but I am often presented with disputes that require resolution after contract formation. Knowledge of dispute resolution options is always a key element of successful dispute resolution, and this recent Federal case adds a new dimension to the analysis.