ADR

Editor's note: This article describes a hypothetical situation.

Bob had his client's orders: “Don't make life easy for the other side. Make them earn their right to arbitrate their claims.”

This looked like an easy assignment because Bob thought he had valid grounds to be a stickler here. After all, the arbitration agreement between Bob's client and the other side did not specify the arbitration provider. It said only that the parties must arbitrate “in accordance with the rules of the American Arbitration Association (AAA) before a single arbitrator, who shall be a retired judge or attorney.” In Bob's judgment, arbitrating “in accordance with” the AAA's rules was a far cry from saying that the AAA would be the arbitration provider.

Bob employed his “strategy” immediately. After the other side filed its arbitration demand with the AAA, Bob did nothing. I mean nothing. He did not respond to the arbitration demand; he did not pay the required arbitration fees, despite several requests from the arbitration provider; and he did not even acknowledge communications, from the AAA or the other side, regarding the arbitration. Surely, Bob thought, his inaction would achieve exactly what he and his client wanted.

Not surprisingly, the arbitration provider threw up its hands and declined to administer the arbitration proceeding for nonpayment of fees. The increasingly frustrated other side to the dispute then filed a lawsuit. Although Bob expressed indignation to the other side—“how can you walk away from the process that the parties must follow?”—he was secretly pleased. Bob confidently told his client that “the plan was working” because the parties “soon” would be back in arbitration, but only after his adversary had become even more frustrated by further costs and delays. Bob told his client that “this strategy will wear out the other side.”

Bob's motion to dismiss the lawsuit for lack of jurisdiction asserted that the parties had a valid arbitration agreement. Which means the other side could not “willy-nilly” ditch the agreed upon dispute resolution process in favor of litigation: “The parties intended to go to arbitration by signing an arbitration agreement. They should remain faithful to their binding and enforceable agreement. The dispute must be arbitrated.”

Bob's argument had a lot of force. The U.S. Supreme Court has said that that the Federal Arbitration Act, 9 U.S.C. Sections 1 et seq., represents Congress' intent “to move the parties to an arbitrable dispute out of court and into arbitration as quickly and easily as possible,” see Moses H. Cone Memorial Hospital v. Mercury Construction, 460 U.S. 1, 22 (1983), and that “'any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration,'” see Mitsubishi Motors v. Soler Chrysler-Plymouth, 473 U.S. 614, 626 (1985) (quoting Moses H. Cone Memorial Hospital, 460 U.S. at 24-25).

In denying Bob's motion to dismiss, the court easily dispensed with the underpinning of Bob's attempt to derail the arbitration. As the court recognized, the arbitration agreement called for the parties to arbitrate “in accordance with the rules” of the AAA. AAA Commercial Arbitration Rule R-2 states that parties who agree to arbitrate in accordance with AAA rules consent to AAA-administered arbitration. Result: arbitration “in accordance with” the AAA rules permits arbitration by the AAA.

More importantly, the court held, Bob's client's failure to advance the required arbitration fees was a material breach of its obligations under the arbitration agreement and constituted a waiver of the arbitration process. Consequently, the court refused to dismiss the lawsuit. The dispute would proceed in court. There would not be an arbitration. Ever.

Bob's strategy delayed the resolution of the dispute by forcing the other side to file a lawsuit, after months of going nowhere. But Bob and his client not only wasted time and money; they now must defend the dispute in court. They lost the benefits of the contractually mandated arbitration process.

This scenario may sound strange, but numerous courts have considered what to do when a party refuses to pay its required arbitration fees. These courts all reached the same conclusion: although there is a strong presumption in favor of arbitration, a party cannot frustrate the purpose of arbitration—to provide a cost-effective and efficient means of resolving a claim—by refusing to pay its required arbitration fees.

The legal basis for these results varies. Some courts have said that the nonpaying party's failure to advance required arbitration fees that results in the arbitration provider's dismissal of the arbitration claim deprives the other party of “the benefit” of the agreement; therefore, the failure to advance fees “goes to the essence” of the arbitration agreement and is a “material breach” of the agreement.

One court concluded that the failure to advance the required fees constituted a “breach of the duty of good faith and fair dealing”; the nonpaying party's failure to pay had the effect of destroying or injuring the right of the other side to receive the fruits of the arbitration agreement.

Another court said simply that the nonpayment was a “breach” of contract, excusing the other side from performance. Yet another court said that the nonpaying party “defaulted in arbitration” and thereby “waived” its right to arbitrate the underlying claim.

Relying on Section 3 of the Federal Arbitration Act, 9 U.S.C. Section 3—which says that a court may stay the trial of lawsuit “until such arbitration has been had in accordance with the terms of the agreement”—some courts have said that the arbitration proceeding “has been had” where the arbitration provider terminates the proceedings due to a party's failure to pay its required arbitration fees.

Although the legal reasoning may vary, courts confronting the issue of nonpayment of arbitration fees have recognized that a contrary result would allow a party to be unreasonably held at the mercy of the nonpaying party (Bob's intention here). This would result in a “perverse incentive scheme”—the nonpaying party could ignore an arbitration demand and, if the claimant did not abandon the claim, later compel arbitration (Bob's plan here) that it again could stymie. This cycle could continue again and again, preventing resolution of the underlying claim.

No matter their legal reasoning, courts have not pulled any punches in strongly criticizing the nonpaying party's strategy. One court even went so far as to refer to it as “a dark side of our nation's policy in favor of arbitration.”

Bob's delay-and-stymie strategy was not original. And the results were easily foreseeable. You think Bob would have employed these shenanigans if he had considered these obvious consequences at the outset?

Charles F. Forer independently provides arbitration, mediation and all other neutral services. He is a co-chair of the Philadelphia Bar Association's alternative dispute resolution committee and is a former chair of the fee disputes committee. He is a frequent lecturer and writer on the use of ADR in a variety of settings. Contact him at 610-999-5764 and [email protected].