Are You Sure You Want an Arbitration Clause in Your Contract?

Are You Sure You Want an Arbitration Clause in Your Contract?

As a business litigator, I have seen many disputes arbitrated where arbitration was not the best forum for the dispute, even though my client agreed to arbitrate in its contract.

Many times, arbitration is the best choice for one of the parties.  But all too often I have seen lawyers include an arbitration clause in a contract as a knee-jerk reaction, thinking arbitration is always the best forum for a dispute.  It is not.  Although businesses may want to arbitrate disputes with consumers and employees, businesses may not want to arbitrate against other businesses.

Let’s start by discussing the many, typical advantages to arbitration, though every case differs.  These advantages include the following: (1) selecting a decision-maker who is more likely to render a fair decision and less prejudicial to corporate parties; (2) scheduling a case definitively without continuances and delays; (3) conducting proceedings confidentially and privately without a public record of the evidence; (4) adjudicating large and lengthy disputes more quickly and less expensively; (5) selecting a decision-maker with specific skills and experience in a particular industry; and (6) precluding certain disputes, such as consumer and employment disputes, from being adjudicated as class actions.

With all those benefits, lawyers sometimes forget the disadvantages of arbitration to their client.  We discuss these disadvantages, not as a negative but as something to consider, because what is negative for one party may be positive for another.  In short, consider these issues before reflexively including an arbitration clause in a contract.

      1. If you represent a party who would likely be a claimant in arbitration of a modest case (under $100,000), then arbitration may not be the best choice. Modest cases are often settled shortly after the filing of litigation, especially when discovery is served quickly, forcing the other side to spend significant costs right away should it decide to litigate instead of settle.  Arbitration, however, does not allow a claimant to commence discovery shortly after the filing of the arbitration demand.  First, the arbitrator must be selected, which can take several weeks, and then a preliminary hearing must be scheduled and held, which can take several more weeks.  Months may pass before any progress is made, delaying what might be a speedy resolution in a court of a modest case.  Moreover, the costs in arbitration, including the filing fees paid to an arbitration association like the AAA, make the upfront costs in arbitration more substantial than litigation, reducing a claimant’s recovery in a modest case that would likely be settled more quickly in court.
      2. If you represent a party that wants to avoid an overwhelming loss, then arbitration may be better than a jury. If you represent a party that would suffer significant, potentially catastrophic losses if it were not awarded 100% of its demanded relief, or if the other party received some of its demanded relief, then arbitration may not be best for your client.  Arbitrators have significant discretion and are not bound by certain laws and evidentiary rules, allowing them to act arbitrarily and “to split the baby.”  Likewise, it is exceedingly difficult to appeal an arbitration award on the merits.
      3. If you represent a party that should prevail in a dispute automatically based on the law, especially a technical rule like the statute of limitations, then arbitration may be unwise. In litigation, a party can file legally dispositive motions, like a motion for summary judgment or a demurrer.  Arbitrators usually do not approve or rely upon these court procedures.
      4. If you represent a party that requires significant information and documents from the other side, such as a party compensated under a contract based on reported financial results from the other side, then your client may want to consider litigating instead of arbitrating. Discovery proceedings in arbitration are usually more limited than in court.  Although arbitrators have become increasingly more willing to allow some discovery, your client likely will be allowed fewer written discovery requests and depositions than in court.
      5. If you represent a party that may want to keep certain bad facts out of evidence, then arbitration may be unwise. For example, some parties have settled or lost prior disputes against other parties involving similar issues.  Some parties have offered or likely will offer to settle a dispute for a substantial amount of money.  Evidence of prior disputes and settlement offers usually are not admitted into evidence for a jury to consider.  In arbitration, however, it is quite likely that the other side will make the arbitrator aware of matters that may not otherwise be admissible.

 

Accordingly, consider all the benefits and drawbacks to arbitration.  Some of these benefits and drawbacks may not come to light until after a contract is drafted, during its performance.  But in drafting your contract, you can access what types of disputes are likely, what type of client and adversary you may have (David v. Goliath), and whether your client is the party who would likely initiate a case.

With our experience in both transactional matters and litigation, including our extensive arbitration experience, we can help you decide whether an arbitration clause is right for you, what arbitration association (e.g., AAA, ADR Services and JAMS) is best, and what other provisions to include that are related to an arbitration clause (e.g., limits on how long an arbitration may last, what discovery is allowed, whether an arbitrator may award attorneys’ fees to the prevailing party, and any pre-arbitration requirement to mediate).