Is That Arbitration Clause Really Good For Contract Parties?

18 Mar Is That Arbitration Clause Really Good For Contract Parties?

Contract are often complex beasts, particularly the “boilerplate” provisions. So-called boilerplate has grown more complex over time and often the terms are not negotiated. In the past, dispute resolution provisions typically involved only choice of law and venue provisions, where the parties agree the law of a particular state will govern the interpretation of the contract and agree to litigate in a particular state or even county. Over the past couple decades, contract drafters have begun inserting form arbitration clauses which force the parties to engage in binding arbitration to resolve disputes.

Similar to the core contract terms, the parties should examine the deal economics when deciding on dispute resolution provisions. While arbitration may be useful for some disputes, parties should not accept without consideration and negotiation a mandatory arbitration clause. Here are four reasons why mandatory arbitration clauses should be actively considered and negotiated.

1. Filing an arbitration is expensive, often three or four times the cost of filing a case in a court. For example, the most common arbitration association, the American Arbitration Association, charges a minimum of $750 to initiate an arbitration for commercial disputes not involving a consumer. That initial fee is for any case with a value in dispute of up to $75,000. If your dispute is worth $80,000, your filing fee jumps to $1,750. By comparison, filing a civil case in federal court costs $400. Filing a case in the state courts of Maryland (where I am) is $165. The American Arbitration Association also charges $800 or more to close a case. The result of the high filing fees for an arbitration is that it forces parties to think twice about filing a case.  If a reasonably foreseeable dispute between the parties is not going to be more than $10,000, why spend more than ten percent to file an arbitration?
2. Not only are filing fees for arbitration expensive, the parties have to pay the arbitrator as well. If you run to the local courthouse and file a case, you don’t pay much more than the filing fee to the court system. You don’t have to pay the judge separately. In arbitration, you do pay the judge for their time, and many arbitrators charge $400-700 hour or heaven forbid even more. You pay the arbitrator not only to hear the case, but to resolve any procedural disputes that arise between the parties. To be fair, if the parties goes to private mediation, the parties still have to pay the mediator, but initiating a mediation does not cost $1,500 in filing fees.
3. Arbitrators are human, but there is no way to check their mistakes. In the court system, if a judge makes a mistake of fact or law, the parties have an appeal right to a higher court. If an arbitrator makes a mistake, there is almost never an appeal right. Lack of an appeal right is a major drawback to arbitration. Honest mistakes by arbitrators happen but there is no mechanism to have another person or set of people take a look at the case. If you lose in arbitration due to a mistake by the arbitrator and the arbitrator refuses to reconsider, you are stuck with the decision.
4. I am not convinced that arbitration actually saves significant money any longer. When arbitration was growing in use, the court system was clogged. Arbitration was a way to get disputes settled quicker. In certain kinds of cases, most notably construction cases, arbitration is much quicker and often in the parties’ best interest. While the courts are still clogged, most courts now have a case management system whereby the the parties have to adhere to certain deadlines to keep the docket moving. Since most cases fall into the case management system (only the most complex cases are not subject to such systems), the cases do keep moving. Both arbitration and traditional court litigation involve discovery, depositions, potentially motions practice, and other procedural matters. They might be expedited in terms of getting them resolved, but since parties in arbitration and traditional litigation are paying lawyers to do this work, the savings of speedier resolution may be lost to lawyer fees.

I don’t mean to suggest that arbitration is necessarily a bad provision for parties to negotiate and agree to. I just believe that parties should negotiate the dispute resolution term. I strongly favor a mandatory mediation provision. If mediation fails, the parties can then go to arbitration or litigation as the complainant chooses. There are many alternatives, but blindly accepting a mandatory arbitration provision in the boilerplate is not necessarily the best choice.