Delaware, Confidential Arbitration and the Risk to Investors (Part 3)

To the extent that a "consent" to arbitrate a "business dispute" appears in an operating agreement, members with claims against the entity may find themselves subject to confidential arbitration in Delaware.  Why does this matter?

Generally arbitration agreements (even mandatory ones) provide a mechanism for selecting the arbitrator that gives both sides a role.  Sometimes both parties must agree on the choice.  Sometimes they each select one arbitrator and the anointed arbitrators pick a third. 

With respect to FINRA actions, where arbitration is mandatory, parties receive a list of arbitrators and can strike those viewed as unacceptable. As FINRA provides:

for claims over $100,000, FINRA will send parties three lists of 10arbitrators randomly generated by the computerized Neutral List Selection System (NLSS)—10 chair-qualified public arbitrators, 10 public arbitrators and 10 non-public arbitrators. Under the majority-public panel method, each party may strike up to four arbitrators oneach list; under the optional all public panel method, each party may strike up to fourarbitrators on the chair-qualified public arbitrator list and on the public arbitrator list. However, under the optional all public panel method, each party may strike up to all ofthe arbitrators on the non-public arbitrator list. After striking arbitrators from the lists, theparties will rank the remaining arbitrators in order of preference and FINRA will appoint thepanel from among the names remaining on the lists that the parties return.

This is not, however, how things work with respect to confidential arbitration in Delaware. 

Rule 97(b) provides that upon receipt of a petition for arbitration, "the Chancellor will appoint an Arbitrator."  Arbitrator in turn is defined in Rule 96.  The term includes "a judge or master sitting permanently in the Court."  In other words, the parties will be assigned an arbitrator from those on the Court.

The identity of the arbitrators has been viewed as something important to "business citizens."  The amicus brief written by the Corporation Section of the Delaware Bar specifically noted that the loss of confidentiality for the proceedings would cause "business citizens" to seek alternatives, thereby depriving them of "efficient dispute resolution before their preferred expert."

These same arbitrators, while the "preferred expert" for "business citizens" may not be the "preferred expert" for investors or shareholders.  Members in an LLC who are subject to confidential arbitration may, therefore, find themselves in a forum with a decision maker that they otherwise would not have selected.   

Moreover, while the "consent" has appeared in operating agreement, it may eventually surface in a company's bylaws or articles, much the way mandatory venue provisions have surfaced.  See In re Revelon Inc. Shareholders Litigation, 990 A.2d 940, 960 (Del. Ch. 2010) ("if boards of directors and stockholders believe that a particular forum would provide an efficient and value-promoting locus for dispute resolution, then corporations are free to respond with charter provisions selecting an exclusive forum for intra-entity disputes."). 

Shareholders, members, and other investors could, therefore, wake up and find that their disputes with the company were subject to confidential arbitration from an arbitrator that was the "preferred expert" of business citizens but not their preferred expert in a forum whereby the right of appeal is limited.  It may be a rude awakening.