Should You Make Mandatory Arbitration Part of Your Business Contracts?
In an article titled “Fortifying Your Customer Contracts”, Max Julian identified the terms and conditions that should be included in a well thought out contract, including dispute resolution procedures. To quote Mr. Julian: “If a dispute does arise, it may be a good idea to require mediation before litigation or arbitration instead of litigation, especially if the controversy involves a large sum of money. Mediation allows for early negotiations outside of the court system, and it can save you substantial legal fees; whereas arbitration is a cheaper, more streamlined alternative to litigation.”Like mediation, arbitration can be written into a business contract in hopes of avoiding litigation and streamlining the resolution process.
But mandatory arbitration has its own pitfalls which make it a risk. By understanding what parties hope to gain – and what they might be giving up – when they opt for arbitration, we can at least make it a calculated risk.
Mediation’s Big Brother
Though sometimes lumped together under the umbrella of Alternative Dispute Resolution, the functions of mediation and arbitration are very different. Where mediation seeks to avoid conflict and oftentimes repair a business relationship, arbitration is a full-on adversarial proceeding.
Arbitration is pseudo-litigation, with the straightforward goal of privatizing a lawsuit. You still have the adjudicator (called the “arbitrator”), the fact-finding, the argumentation, and the passing down of a decision. What you hopefully avoid is the time and monetary pitfalls that come with formal litigation.
Arbitration, the Path of Least Resistance
Arbitration is appealing in part because of its streamlined structure. Depending on which set of rules you follow – the American Arbitration Association (AAA), Judicial Arbitration and Mediation Service (JAMS), the Center for Public Resources (CPR), or some ad hoc rules that leave administration to the parties themselves – the rules of litigation are pared down for efficiency.
As a direct result, it takes significantly less time to reach a resolution: six months at the outside. The parties are also in charge of scheduling deadlines, so the process can move at the appropriate speed. And with abridged processes and a speedier trial, arbitration usually costs far less than litigating.
Finally, arbitration, unlike litigation, is private. No facts or details of settlements will automatically become public record; but if such information is truly sensitive, the parties should sign a nondisclosure agreement.
In arbitration, the parties can pick not only the set of rules that will ultimately determine their fate, but the decision-makers as well. This allows for experienced arbitrators with applicable, and even specialized, business expertise and an approach to problem solving that the parties can appreciate.
Arbitrators usually focus on fairness and equity rather than procedure. For this reason, dismissals based on technicalities and runaway verdicts (e.g. statutory damages) are almost unheard of. The parties can also agree to have high and low caps on damages or other agreed upon parameters.
Finally, arbitration can preclude class actions, meaning that a defendant won’t be dealing with a whole class of litigants. This often benefits companies that deal directly with the public.
Arbitration Gone Awry
For all the good that arbitration can bring, its streamlined nature can work against equity and open the system to abuse.
Most importantly, arbitrators have nearly unbridled power. An arbitrator’s decision will likely be final since there is no appeal process as long as the arbitrator has used reasonable discretion and followed the established rules. Because arbitrators have more discretion and procedural and technical safeguards are lacking, there is a lack of accountability and therefore a greater susceptibility to improper influence.
An important takeaway here is to choose your decisionmaker wisely.
Other arbitration pitfalls:
- Abridged discovery process may leave important facts and evidence undiscovered
- No summary judgment, so full arbitration of an issue is often necessary
- Winning on procedural or technical defenses (e.g. statute of limitations) is very difficult
- Emerging policy issues don’t fare well in arbitration
Arbitration resolution does not act as collateral estoppel; unless arbitration is mandatory and binding, as in a business contract, parties can litigate the same issue that was arbitrated