November 2, 2015

Arbitration Clauses and Unknown Unauthorized Sellers


Arbitration has become so popular, brands often include arbitration clauses in authorized seller agreements as a matter of course. However, in the fight to stop unauthorized online sales, these clauses can create a problem when legal action is necessary to pursue an unknown breaching seller.

By way of example, imagine that certain unknown sellers are violating their authorized seller agreements by selling products on the internet or to resellers. To learn the identities of the non-compliant seller, the business might want to file a “John Doe” lawsuit and serve subpoenas.

The strongest and most direct claim in the business' complaint would be breach of contract against the unknown seller. However, in this example, the brand's seller agreement contains a mandatory arbitration clause. And this clause requires that the parties arbitrate (not litigate) all contract disputes.

The problem arises because there is no method of filing an arbitration action if the business does not know the breaching distributor's identity. Arbitration, after all, is a matter of agreement between parties. And even assuming a business could unilaterally file an arbitration proceeding, there is no assured means of obtaining third-party discovery through it.

The Federal Arbitration Act does not contain any provisions permitting third-party discovery. Meanwhile, the federal circuit courts are split as to whether an arbitrator has the power to compel third-party discovery. And many other jurisdictions have not decided the issue one way or the other.

Right now, the ability to get third-party discovery in arbitration is suspect at best. Therefore, the question becomes: how can a business get the benefits of these clauses while still having access to the courts in these types of situations?

One possibility is to have a permissive arbitration clause instead of a mandatory clause. Permissive clauses allow parties to arbitrate or litigate at their choosing.

However, truly permissive clauses are unhelpful. If either party can go to court, the business does not get the benefit of arbitrating.

Instead, it is helpful to have a clause that makes arbitration binding on one party (the seller), but permissive on the brand. The problem with this is that some courts have found such clauses to be unenforceable.

Therefore, a better (and generally more enforceable) option is to have a carve-out from the clause that allows a lawsuit when the identity of the seller is unknown. In a sense, this is a narrower carve-out compared to a unilateral arbitration provision. And this allows one party to avoid arbitrating for any reason.

With this sort of carve-out, a business would be able to bring John Doe litigation against an unknown seller and serve subpoenas to identify him or her. Once identified, and depending on the scope of the carve-out, the business could proceed with litigation or then move to compel arbitration.

Even if a brand’s current seller agreements do not have the carve-outs, all is not lost. One strategy to consider is filing a John Doe lawsuit to compel arbitration. After a business files a lawsuit, it can serve a subpoena to identify the John Doe seller.

Thus, once the brand identifies the seller, the brand can resolve the issue with the seller or ask the court to compel arbitration based on the agreement.

In short, arbitration clauses can be problematic in instances of unauthorized sales by an unidentified seller. However, a forward-thinking company can avoid this problem with the proper carve-outs or a creative pleading to compel the parties to arbitrate.