Mandatory Arbitration Clauses; Are They Right For Your Business Contracts?

For nearly two decades private arbitration of business disputes has been promoted as a preferential alternative to traditional courtroom litigation. Arbitration became such a wildly popular concept that many drafters of business contracts began to automatically include mandatory arbitration provisions in those contracts without giving adequate consideration as to whether arbitration would serve the company’s best interests in the event of a dispute. While arbitration does have its benefits under certain circumstances, here are five potential disadvantages that business owners should be aware of before inserting mandatory arbitration clauses into contracts.

Cost

Arbitration was originally promoted as a way of keeping litigation costs in check by means of limited discovery and an expedited hearing. However, arbitration presents costs that traditional courtroom litigation does not such as arbitrator fees and higher filing fees. Serving as an arbitrator has become a lucrative practice area for many attorneys and former judges with rates typically in the $500 per hour range for commercial disputes. Assuming a moderately complex business dispute, it is not unreasonable that an arbitrator could incur $40,000 in fees from start to finish. Now consider that some arbitration provisions call for the selection of three arbitrators to decide the case which means that the arbitrator fees would increase to $120,000. Meanwhile, the judges in state and federal court will hear the case at no charge. Filing fees are also much higher in arbitration and can exceed $7,500 depending on the amount in dispute between the parties. Filing the same case in state or federal court would cost less than $500.

Lack of Discovery

The arbitrator will be able to summon witnesses via subpoena to appear before the arbitration panel to give testimony or produce documents. If a witness fails to comply with the arbitrator’s subpoena the parties must seek enforcement of the subpoena in the federal court for the district in which the arbitrators are sitting and asking the federal court to enforce the subpoena. However, federal rules limit the jurisdictional reach of a court’s subpoena power. Thus, parties engaged in an arbitration hearing in Chicago would not be able to subpoena witnesses or relevant documents from a non-party located in Texas for example. This limitation on the means to conduct discovery can impair the ability to develop and present an effective case.

Inconsistency

Business owners generally assume that the arbitrator deciding their dispute will apply the law and rules of evidence just as a judge would do. This is not necessarily the case. One particular arbitration rule states that “Conformity to legal rules of evidence shall not be necessary.” This may allow for the admission of evidence that generally would be excluded at trial. Further, while it seems logical that the arbitrator must come up with a remedy that conforms to the law of the applicable jurisdiction, the rules of arbitration give a great deal of discretion. One example is an arbitration rule that provides “The arbitrator may grant any remedy or relief that the arbitrator deems just and equitable and within the scope of the agreement of the parties…” Note that the rule does not mandate that the arbitrator to grant a remedy or relief as required under law.

Delay

One thing that all litigants want is a quick resolution of the dispute. Typically, arbitration rules provide that the arbitrator’s award shall be made no later than 30 days from the date of the closing of the hearing, unless agreed by the parties. However, it is not uncommon for the arbitrator to request additional time to complete the award. Since neither party wants to risk offending the arbitrator, these requests for extension are typically granted and decisions can take up to 120 days or more to issue. Trying the same case before a jury would result in a decision within a few days at most after completion of the case.

Lack of Review

Arbitration awards are final and generally not subject to appeal. Thus, business owners run the risk of no recourse if an award is factually incorrect or the arbitrator misapplies the law. Under very limited circumstances a federal court may review an arbitration award to determine if the arbitrator exceeded the arbitrator’s authority or engaged in some misconduct in coming to his decision but such review is infrequent.

Arbitration is not a one-size-fits-all solution for business disputes. Some disputes are better suited for traditional courtroom litigation which will provide the parties with the ability to conduct sufficient discovery to adequately prepare and evaluate the case, ensure the application of the applicable rules and law, provide for judicial review and avoid the rising cost of arbitrator fees. Business owners should consider whether arbitration would meet their needs and expectations before incorporating such provisions into their contracts.

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