Arbitration clauses -- they seem like standard boilerplate in a generally dull blob of text buried in the fine print of many contracts governing everything from purchases of music on iTunes to collective bargaining agreements between a labor group and its members. You click the “I Agree” button or sign the contract without a second thought as to anything negative happening between you and the other side.
But what happens when Murphy’s Law hits and you find yourself on the precipice of a protracted legal battle with an opponent? “Not to worry,” both parties might say. “We signed an arbitration clause, so that means we won’t have to duke things out in court”. Riiight.
Arbitration clauses may indeed make it quicker and more efficient for parties to a dispute to sort out their differences, but there are many cases where the result can be anything but fair for one of the parties. Lax rules on what evidence can be presented in support of a claim, custom rules on procedures followed by parties in presenting their claims and supporting evidence, and lack of an ability to appeal an adverse ruling all contribute to a process that one party might find very lopsided. Indeed, a recent New York Times article discussed some of the pitfalls of this “privatized justice system” that impacts a whole diverse set of claims pertaining to employment discrimination, fraud, even wrongful death.
The reality of doing business is that both sides want to find the most cost-effective way to accomplish a certain goal, without the hang-ups of fighting over terms of a deal. Arbitration clauses were once seen as instruments that could be used to achieve such ends because they offered flexibility and certainty. Arbitration may be cast as a type of resolution procedure where both parties have the potential to gain, but arbitration can sometimes run as a zero-sum game. There are some things that both sides to any agreement should be aware of when deciding whether to include arbitration in the contract as a means for resolving differences.
Does Arbitration Make Sense?
While there are some cases where arbitration clauses have been deemed to shift the balance of power into the hands of the party with the most negotiating power (i.e. major corporations seeking to prevent certain types of class action lawsuits), in many cases, arbitration is a tool that two sides to a transaction should figure out how to use. Why? Because arbitration may actually be a means for encouraging more cooperation and business-minded decisions than the traditional legal process, which might lead both parties to an impasse. Indeed, legal action sometimes ruins any prospect of long-term business relationships and puts transactions and business operations on hold, frustrating the original intent of two parties to the contract.
Some of the main benefits of including arbitration provisions in contracts include:
- Parties know where the action is at: Arbitration, because it minimizes the potential for protracted litigation, actually lowers the cost of doing business. In an arbitration clause, parties can choose where arbitration will be held and what issues from the contract the arbitration can reach. This provides the parties to a contract with some predictability and can allow a party to lower the cost of doing business, passing these cost savings onto consumers. Furthermore if both parties can agree on arbitration (perhaps at a neutral site), this removes the parties from being on an adversarial footing from the very beginning, fostering a more productive business relationship.
- Parties can select the fact finders: Unlike judicial proceedings, arbitration does not have to be presided over by a judge. Instead, parties could choose a subject matter expert or someone that has industry experience and who could better resolve the dispute between two parties. For example, if the dispute involves an issue of software distribution and whether the distributor of the software over-stepped the sales territory by offering a smartphone app from a different company, the parties may want to select an arbitrator that is versed in the intricacies of software development and distribution methods.
- Parties can create their own procedural rules and define the structure of the proceedings: Because arbitration is defined within the confines of a contract, parties can design the arbitration process to accommodate their needs and interests. Procedural rules that are ordinarily applicable in court proceedings, normally dictated by state and federal statutes, can be abrogated in favor of efficiency. For example, the type of evidence that can be introduced, how the arbitration proceedings are conducted by the arbitrator, even the arbitrator selection process itself can all be negotiated and decided by the parties. Parties can either elect to address these issues at the contract stage or later on during arbitration.
- Enforcement across borders in international arbitration: Perhaps one of the greatest benefits of an arbitration agreement is that it gives parties the ability to enforce an arbitrator’s decision across borders. The ability to select the substantive law and rules that govern the proceeding along with a neutral venue makes it far easier to resolve disputes. Under the United Nations Convention on Recognition and Enforcement of Foreign Arbitral Awards of 1958, 145 signatory countries are required to recognize and enforce international arbitration agreements and foreign arbitral awards issued by other contracting states.
Avoiding the Zero-Sum Game
The tricky part is negotiating an arbitration clause that will provide the most efficient process while avoiding a lopsided result.
- Provide a right to an appeal: Although counter-intuitive to the whole goal of avoiding litigation, some arbitration agreements include a right for parties to appeal the arbitrator’s decision. To prevent long, drawn-out litigation, the arbitration agreement can specify issues that are appealable.
- Clearly define the scope of arbitration and the applicable arbitration rules to prevent litigation 2.0: If the parties can anticipate the kinds of disputes that will arise, they can easily define what rules should govern the proceedings. Furthermore, where the issues are likely to be heady (i.e. disputes over ownership of intellectual property), it may be more beneficial to reserve those for litigation where courts have created a bevy of case law that helps judges (and parties) more clearly enunciate a legal standard to decide the dispute.
- Money, money, money: Arbitration, just like litigating in court, costs money. Parties have to agree on how to cover the cost of arbitrators. Other costs include attorneys’ fees for both sides. It is typical for both parties to split the cost of the arbitrator and pay for their own attorney. Still some agreements propose that the loser in the arbitration pays for everything (if there is a clear loser, as defined by other provisions in the arbitration). Of course, if one party to the agreement is smaller and doesn’t have funds to cover the cost of arbitration, the parties could agree to some kind of jointly-funded arbitration fund from revenue associated with the project, where funds are placed in an escrow account and used later to cover expenses. If one party agrees to fund the arbitration entirely, both should make sure there is some kind of impartial method for selecting the arbitrator.
If you Arbitrate, Get it in Writing
Unlike regular court proceedings in a state or federal court, arbitration must be agreed-to in advance by the parties. Moreover, the arbitration must be specific to one type of dispute (or a group of disputes) between the parties. Parties cannot be forced to submit a specific dispute to arbitration unless there is some contract authorizing it. Writing down the procedures that are to be followed during arbitration is crucial, especially if the parties want to be able to enforce any award outside the U.S. Moreover, the arbitration clause in any written contract must specifically address specific powers of the arbitrator to provide certain kinds of relief such as money damages or granting injunctions against one party to compel a particular action.
Talk it Out
Many arbitration provisions are seen as “take it or leave it”, especially by parties that feel they have unequal bargaining power because the party driving the negotiations has more chips. However, contract terms can be discussed and often modified, even with a party that feels like it has the power to impose unfavorable terms on a smaller potato. When it comes to contracts between businesses, the main concern on both sides is getting the deal through as opposed to just driving a hard bargain. If one side to the negotiations insists on a stringent arbitration provision but they want the deal bad enough, they may be willing to relent if the other side threatens to call-off negotiations. In this case, a counter-proposal in arbitration (perhaps by agreeing to a wider scope of issues that can be arbitrated, but building in a right to appeal), can help even out an arbitration provision. If a party is unwilling to budge? It may not be such a promising forecast of things to come.