Carve-Outs and Contractual Procedure

Abstract

The burgeoning literature on private contractual choice of procedure has run up against a difficult empirical reality: the available empirical evidence reveals surprisingly little use of customized procedural rules in contracts between sophisticated parties. One likely reason for so little customization is that contractual relationships entail multiple risks, and it is very difficult to specify customized procedures that would optimally handle all potential disputes. In this article, we identify and analyze an alternative mechanism by which procedural customization commonly takes place in contracts: the use of carve-outs from arbitration. A carve-out is a contract provision by which the parties exclude (or carve out) certain claims or remedies from their arbitration clause. Carve-outs are a mechanism by which parties choose between court and arbitral bundles of procedures on a claim-by-claim basis. The claim-based choice makes more sense in that it enables the parties to choose procedures tailored to individual contractual risks. With such clauses, parties are able to obtain a more carefully calibrated procedural customization than provided by an arbitration clause or forum selection clause alone, but at a much lower overall cost than they would incur by attempting to develop customized procedural rules. This article sets out a model of the decision to use carve-outs and provides a detailed empirical examination of their use. Our analysis has a number of implications for the continued necessity of courts and their governing legal rules, the legal enforceability of carve-outs, and court treatment of the severability of claims from arbitration clauses more generally.