Gary Pemberton, litigation partner at Shulman Hodges & Bastian LLP, is always amazed at how often businesspeople negotiating a contract consider arbitration clauses to be the Holy Grail.
“I think that’s a mistake, because arbitration is not necessarily the best vehicle for every type of dispute,” he says.
“Before you even place an arbitration clause in a contract, put a lot of thought into whether it is right for the deal you are negotiating. If it is, try to visualize what kind of potential disputes could arise with the contracting party, and then tailor the clause to address those contingencies.”
Smart Business talked to Pemberton about the pros and cons of arbitration clauses.
What are the advantages of arbitration provisions in contracts?
One is privacy. Unlike litigation, arbitration does not involve a public filing, a public litigation and a potential public trial. It is conducted behind closed doors, generally with no court reporter, there’s no file for the public to review and, generally, the decision is kept confidential.
Arbitrations also tend to be quite informal, rules of evidence are relaxed and discovery is limited, making them typically less expensive. They are also more convenient; you can agree on an arbitration date and be fairly certain that the case will be arbitrated the day that it is set.
If the matter is complex, you can select arbitrators that have expertise in the matters being litigated, unlike a court proceeding where the jury won’t and the judge may not have that expertise.
One of the nice things about arbitration especially with two parties that want to continue to do business together is that it tends to be more civilized. Unlike court litigation, there’s usually not as much acrimony and good business relationships don’t go down the tubes.
What are the disadvantages?
Things go wrong. The reasons that companies originally wanted to arbitrate turn out to be diametrically opposed to what actually occurs.
First, arbitration is not always quicker. Simply whether a case is required to be arbitrated may be litigated itself. If the parties do not agree that the arbitration clause is enforceable, you can spend a year litigating whether the clause is applicable. Arbitrations also can get expensive. Arbitrators can bill out at $3,000 to 5,000 a day for their services. For a panel of three, that’s a lot of money especially where, unlike California state courts with their fast-track requirements, there is no formal incentive to efficiently use time and move a case along.
Unlike a court trial, there’s generally not a mechanism to dismiss a meritless case with a summary judgment procedure. Even the most frivolous arbitration cases may be taken all the way to a hearing.
Also, there is no mechanism to compel third parties who belong in the arbitration but were not parties to the arbitration agreement to be brought into the arbitration.
Results can be less predictable since arbitrators are not required to follow the law and there is no right of appeal simply because the arbitrator gets the law or the facts wrong. There’s also the belief that arbitrators tend to compromise too much.
Because there’s no right of appeal from an arbitration award simply because it is wrong, you can be stuck with a bad the decision, whether it’s right or wrong, unless you can demonstrate it was the result of fraud or the arbitrator is not truly impartial. (It’s believed at least by some attorneys that not all arbitrators are truly neutral. They are human like everybody else, and in order to continue getting business from companies or attorneys involved in a lot of arbitration disputes, they don’t want to make those companies and attorneys terribly unhappy.)
What factors should a company consider before deciding to put an arbitration clause in a contract?
- If a dispute develops, who will have the evidence? If your adversary in an arbitration will have all the witnesses, evidence and documents, not having significant discovery can be a substantial detriment, and arbitration may not be right for you.
- Do you want to have summary judgment and adjudication procedures included in the arbitration clause? When you’re involved with a party that historically files frivolous lawsuits, it’s wise to do so.
- How is the other party in the contract viewed in the community as opposed to your company? If your potential opponent has a great reputation, you might not want to be in front of a jury and might want to go the arbitration route.
- How crowded is the local court’s docket? If it’s heavily congested, it’ll probably take longer to get the matter resolved than an arbitration would take.
- How important is your company’s public image? Arbitration’s privacy will minimize the impact of litigation on your company’s image.
- Will the issues in a potential conflict be simple or complex? If complex, you might want the expertise of an arbitrator.
- Is there a concern about potential punitive damages? Juries are more likely to become impassioned and hand out punitive damages, sometimes excessive. Arbitrators tend to be more reasonable and less emotional than juries.
GARY PEMBERTON is a litigation partner at Shulman Hodges & Bastian LLP. Reach him at (949) 340-3400 or email@example.com.