Five Essential Contract Terms for Consultants, Independent Contractors, and Freelancers: Part 3-Dispute Resolution Process

Five Essential Contract Terms for Consultants, Independent Contractors, and Freelancers: Part 3-Dispute Resolution Process

This is the third post in a five part series on Essential Contract Terms for Consultants, Independent Contractors, and Freelancers. This post will focus on dispute resolution clauses.

If you are in business long enough, you will encounter a dispute of some sort; be it with a customer, a vendor or a business partner. While proactive relationship management can deter a vast majority of disputes or at least allow for a settlement of the dispute through informal discussions, even the most personable and proactive knowledge worker may face a dispute. We live in a litigious society and often a wronged person’s first reaction is to run to the courthouse. But more than ninety percent of non-family law civil cases filed in this country settle before trial. Often the process of achieving the settlement is costly in terms of time, money and stress.

As I have stated, a contract is a written description of how a business relationship will operate in the world.  No contact party enters into a contract with the intention to have a dispute, human nature makes disputes at least possible.  The parties to a contract should consider carefully how disputes between them will be resolved and should clearly describe the dispute resolution process in the contact. For the remainder of this post, I will assume that informal methods of dispute resolution have failed.

In general, there are three formal dispute resolution procedures: Litigation, Arbitration, and Mediation.

Litigation is the formal filing of a law suit in a court of law.  Even small claims court is litigation, albeit on a smaller scale.  Litigation has formal rules; the procedure is spelled out, available to all, and enforced by the judge. The macro level of the proceeding is very predictable, although the micro-level details will change.  Outside of small claims court or lesser claims (under $20,000), litigation is expensive and time consuming. The calendar is set by the court and the parties often apply for and receive extensions of the calendar, drawing out the process. Litigation and the courts are there to determine a winner, and after years of litigation experience, I have learned that even if a party wins in court, they still lose.

Arbitration is best described as a private court. The parties contract with an arbitration service or directly with an arbitrator who is often a retired judge or experienced attorney. The parties agree to a set of rules either promulgated by the arbitration service or using a modified version of the local court rules. The parties conduct discovery, brief the arbitrator and then present a case comprising the facts and the law.  The arbitrator then issues a binding ruling on the parties which can then be taken to a court of law to be enforced if necessary.

Mediation is a form of collaborative law (the newer term for a variety of mediated dispute resolution techniques) whereby the parties work with a neutral third party to arrive at a settlement. The parties exert far more control over the process, including a lesser role for lawyers, and the mediator serves as a guide to bring the parties to a mutually agreeable resolution.  Mediators do not make decisions for the parties and outside of court ordered mediation, the process is generally voluntary.

Approximately thirty years ago, larger, sophisticated organizations began including mandatory arbitration clauses into their contracts in order to avoid the crowded court system. These clauses, in almost every situation, have been upheld by the courts as binding, often to the detriment of consumers and small businesses. So when a complaining party filed a lawsuit in court, the large organization would point to the mandatory arbitration clause and the court would dismiss the case.  Arbitration favored larger organizations.  Over time, lawyers working on smaller contracts for a variety of businesses, began including mandatory arbitration clauses. Initially, the arbitration process generally saved the parties money and moved quickly.  But today, outside of a few discreet subject areas (such as construction law), arbitration has become nearly as expensive as litigation and often just as time consuming.

Arbitration also has one big drawback that I distrust–there is no right of appeal!

In litigation, if the trial judge makes a mistake, each side has the the to appeal to the higher court.  The higher court serves an error-correction function since judges sometimes make mistakes, misinterpret the evidence, or misapplies the law. The appeal process puts another set of eyes on the case to ensure as much fairness as possible.  But in arbitration, if the arbitrator makes a mistake, misinterprets the evidence, or misapplies the law, there is no right to an appeal.  Most arbitration clauses do not allow for a traditional court of law to conduct a review of the case. Thus there is no mechanism to correct a mistake by the arbitrator, and if you are on the wrong side of the mistake, it can be heart-breaking as well as expensive. I counsel my clients to take as many practicable steps as possible to avoid a mandatory arbitration clause. Instead, I encourage mandatory mediation, with a right to go to litigation if the mediation fails.

As noted above, 95-97% of all cases settle before a trial.  A large fraction of those settlements come through court-ordered mediation, enough such that most courts require or strongly encourage the parties to go to mediation.  If even the mediation does not actually result in a settlement, the process of mediation often puts the parties in a less confrontational position or puts the dispute in a different light so that the parties themselves arrive at a resolution.

To avoid ambiguity in the dispute resolution section, knowledge workers should make clear the preferred process of mediation. A mandatory mediation clause should include the following terms for the parties to

  • expressly agree to go to mediation first to resolve their dispute
  • make a good faith effort to resolve the matter in mediation.
  • raise the dispute shall do so in a formal manner, through the notice provisions in the contract
  • stipulate the party raising the dispute shall provide a list of at least three and no more than five mediators available to conduct a mediation within 90 days or less
  • require the party receiving the mediation demand choose one of the proffered mediators within a specified time frame such as ten to fourteen days.
  • acknowledge the only grounds for denying all proffered mediators being a conflict of interest.
  • split the mediator’s fees evenly and pay the mediator directly.
  • agree to a minimum of mediation time. The length of time will vary depending on the size of the contract and the size of the potential disputes.
  • consider the option to toll the statute of limitations on the dispute during the mediation.
  • expressly agree if the mediation fails to produce a settlement, the parties are then free to pursue the rights and remedies available to them under the contract and the law.

The Dispute Resolution clause should be fairly detailed. The most important matter for this clause is to make sure it is clearly understood.

Summary

The written contract is a description of how a business relationship will proceed. Proactive relationship management can resolve many disputes, but disputes are likely to happen and smart contract drafting can provide a clear path to resolving the dispute with as little expenditure of time and money as possible.

While litigation is expensive and time-consuming and has traditionally been so for decades, the preferred method of arbitration is now nearly as expensive and time-consuming.  Furthermore, unlike litigation, arbitration has no appeal process to minimize the impact of mistakes by the decision-maker.  Mediation, however, is a party-focused method of guided dispute resolution.

Knowledge workers, particular small businesses and sole workers, would be far better served with a mandatory mediation clause that requires the parties to a contract attempt to settle their dispute before running for the courthouse.

 

The Law Offices of Matthew S. Johnston, LLC strongly encourages mandatory mediation as a dispute resolution mechanism.  We can help knowledge workers and others to craft a mandatory mediation clause that suits their needs.  Contact us to learn more.

What kind of dispute resolution clauses have you seen or agreed to that you regret?  Have you ever been involved in business dispute mediation?  Let us know what you think about mandatory mediation.

 

Also in this series: