Should You Make Mandatory Arbitration Part of Your Business Contract? - Daniel Ross & Associates

Previously, we introduced alternative dispute resolution and reviewed the approach to mandatory mediation clauses in business contracts. Arbitration is, of course, the other main body of ADR. And 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 ADR umbrella, 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.

Tailor-Made Lawsuits

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 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.

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.

A most important takeaway here is to choose your decision-maker wisely.

Here are some other arbitration pitfalls to consider:

  • 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


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