Entrepreneurs Should Pay Attention to Arbitration Clauses in Contracts with Bigger Companies

Arbitration clauses are typically an afterthought. Entrepreneurs ready to strike a lucrative deal with a larger company are usually focused on the opportunity, rather than the risks. Besides, corporations frequently suggest that they will walk away from the table if the entrepreneur demands that such clauses be stricken from the contract or altered in some form or fashion.
In many ways, arbitration clauses are baked into the way the corporation does business.

Such was the case with Pepperidge Farms, Inc. (PF), a wholly-owned subsidiary of Campbell Soup Company, when it informed one of its distributors, Phillip M. “Mike” Hewson of San Antonio, in writing that it intended to re-acquire Hewson’s rights to service “club stores” such as Sam’s Club and Costco within his exclusive marketing territory in South Texas.

But after negotiations between the two sides to determine the fair market value of those rights broke down, PF allegedly ceased paying Hewson for sales to club stores, and dragged its feet on arbitrating the amount that it owed Hewson. Frustrated by the delay, Hewson, with the help of attorneys Paul T. Curl and Herbert S. Hill of the San Antonio law firm Curl Stahl Geis, sued in state court in a bid to “enforce the arbitration provisions of paragraph 20 of the Consignment Agreement” between PF and Hewson.

The Consignment Agreement provided that if PF “elects to purchase all or any portion of the Distributorship pursuant to this Paragraph, it will pay to Consignee [HEWSON] a sum equal to (a) the fair market value of the Distributorship, or the portion thereof being purchased, as the case may be, on the date set forth in the written notice plus (b) 25% of such fair market value, to be determined either by agreement between Bakery [PF] and Consignee or, if they shall be unable to agree, by three arbitrators, one of whom shall be chosen by Bakery and one by Consignee and the third by the two first chosen. Each party to such arbitration shall pay all fees and expenses incurred by it in connection with such arbitration, including, without limitation, the fees and expenses of the arbitrator chosen by it; and the fees and expenses of the third arbitrator shall be shared equally by Consignee and Bakery.”

Curl said that PF “continues to delay,” and has even threatened Hewson with sanctions for seeking to compel arbitration. PF removed Hewson’s suit to federal court in San Antonio, then filed a motion seeking to dismiss the suit even though, according to Curl, PF concedes that prompt arbitration is required under its agreement with Hewson. Curl noted that his client “did not want it to come to this. We just could not sit idly by while this company took as long as it wanted to pay our client while denying him the revenue from the club stores. He deserves better.”
Because this is such an important issue for entrepreneurs, I sought out Curl for a brief interview.  Here are some questions I asked him:

Q: Why are arbitration clauses in contracts such a big deal between a small business owner or entrepreneur and a corporation?

A: Arbitration clauses are a big deal because they constitute a waiver of your right to go to court, and particularly to have a jury decide your case. In addition, some arbitration clauses are so one-sided that they limit your ability to assert your rights in the event that you have a problem with the other party to the agreement. Arbitration can also be more expensive than litigation in court, which works to the advantage of the party with deeper pockets. Moreover, the outcome of arbitration is usually final and unappealable. Before agreeing to an arbitration clause, you need to understand exactly to what you are agreeing.

Q: At what point should the small business owner or entrepreneur bring up the arbitration issue?

A: The arbitration clause must be discussed before the contract is signed. After that, under Texas law it is extremely difficult to escape enforcement of an arbitration clause.

Q: At what point should they engage an attorney?

A: In some contracts, you have no leverage to negotiate the terms of an arbitration clause. But if you can negotiate, an attorney should review and negotiate the terms of an arbitration clause before the contract is signed.

Q: What are the advantages of engaging an attorney?

A: An experienced attorney can tell you whether an arbitration clause is fair, what the advantages and disadvantages of a particular arbitration clause are, and what alternatives there may be to an arbitration clause.

Q: Let’s say a dispute has surfaced and there is an existing contract. What are some of the things the small business owner should notice in the language of the contract?

A: The first things to look for in an arbitration clause, after a dispute has arisen, is whether or not arbitration is mandatory, how arbitration is to be initiated, and who must take the first step. For example, if the contract requires arbitration under rules of the American Arbitration Association (AAA), the claimant initiates arbitration by filing a demand for arbitration with the closest office of the AAA, unless the contract states that the demand is to be filed in a specific, different office of the AAA. The AAA will require a filing fee, which may be substantial. Another type of arbitration clause may say that “either party,” may initiate arbitration, in which case it may be better to file a lawsuit and see if the other party asks the court to refer the case to arbitration. By filing suit first and waiting to see if the other party demands arbitration, if may be possible to avoid arbitration, or at least shift the burden of paying the filing fee to the other party. The terms of arbitration clauses can vary substantially, and each must be carefully examined.

Q: Is it too late to engage an attorney?

A: It’s not too late, and it is absolutely necessary, since he or she will guide you through the process, and having an attorney is just as necessary in arbitration as it is in a lawsuit.


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