The Problem with Arbitration and a Solution

Having spent several years in litigation practice, day in and day out all I dealt with were partners who were suing or being sued. I concluded that while litigation is an important part of the American legal system, it is also very wasteful. It is not designed to help parties find a resolution, rather it is designed to have a third party impose a solution to the problem.

For this reason, I am vocal in my opinion opposing arbitration outside of a few very discrete cases. One of the biggest faults I see in arbitration is that it is strictly adversarial, meaning that there is a person, or in some cases a panel of people, whose job it is to make a decision. They must determine a winner in a dispute. Arbitration leaves no room for finding a solution to the problem. The parties and the arbitrator work the process and then the arbitrator, like a judge, picks a winner and a loser. On the other hand, I am a big fan of mediation, where a mediator serves as a disinterested third party whose sole job is to work the problem as it is presented. Instead of working the process between the parties and then picking a winner, a mediator helps parties find a solution to the problem.

With that background, a couple of interesting things have come across my desk the past couple of days. The first is a case out of New York state called Korangy v. Malone, NY Slip Op. 03767 (1st Dept May 24, 2018). The facts of the case are pretty unremarkable. The case was a straight business dispute between business partners that owned a piece of commercial real estate. A dispute arose about the allocation of money in the business. The partners had a provision in their partnership agreement that called for binding mediation. I don’t know the motivation behind the decision to have a hybrid dispute resolution mechanism, but it became the core of the dispute.

The parties had a dispute and then initiated the mediation process, but in this case, the mediator had the power to make a decision (which is not the normal process), and that decision became binding upon the parties. Ultimately the decision of the mediator was not the issue in the case, but process the parties chose presented an interesting amalgamation of mediation and features of arbitration. I’m not sure how the parties or the lawyer who drafted the agreement between the parties came to this decision in structuring this dispute resolution mechanism, but it is interesting.

Binding mediation seems to me to be inefficient and not very clean. It doesn’t appear as though the parties thought through the mechanism or the consequences of a dispute resolution mechanism. The attorneys who helped them draft this agreement likewise did not think through the possible ramifications. Or, perhaps they were so interested in creating this hybrid system that they did not prioritize any evidence of its potential effectiveness. The dispute resolution mechanism between the parties was not effective since they ended up in court, and eventually an appeal. Thus, binding mediation was not an effective solution.

Another item came across my desk as I was in the search for an alternative mechanism for managing disputes between companies from different countries. This is often a difficult question to address because if the companies are both inside the United States there’s is a recognition that it doesn’t matter a great deal where the parties end up, whether in court in state A or state B. The rules are generally the same.

That’s not always the case when you’re dealing with companies from different countries.

In the United States, we have a legal system for contract disputes that is heavily based on notions of prior law, case precedent, or common law principles for determining the outcome. Other countries have a more codified structure for managing commercial relationships, dispute resolution, and courts. Often, choosing one nation over the other is difficult because each party is used to their own system. While I was working for a client trying to figure out a way to appease their client about this concern in dispute resolution I came across a tiered structure that contained features that I had not seen so well-structured before. Essentially in the tiered structure if there is a dispute the chief executives of the companies will sit down and try to negotiate a solution. I strongly encourage that. It often works.

But, if that doesn’t work, then they go to a mediation, and this mediation would be administered by an organization that has people who are experienced mediators. If the mediation doesn’t work or doesn’t resolve all the issues, then the parties go to arbitration. One of my biggest disputes with arbitration has long been that arbitrators are human. Arbitrators may make mistakes, not out of any malice, but simply because they are human. Adding to the problem, arbitrations generally do not have any appeal right. You do not have the mechanism to have somebody else look at the case again, and say “yeah, the arbitrator did that right” or “the arbitrator made a mistake that she needs to fix.” If you go through the court system and a trial judge makes a mistake, the parties have an appeal right This right to appeal allows another bank of judges to look at that decision and say whether or not that properly followed the law. You have the right to address what you believe is a mistake, and to have a third party body determine whether it was a mistake or not.

Most arbitrations do not include the right to appeal, and that is one of the main issues I have with arbitration.

While working to find a dispute resolution mechanism for this client, I came across an arbitration mechanism that had an appeal panel. That makes me more comfortable when dealing with my client and achieving my goal to advance their interests. Mediation is fantastic, and I firmly believe most disputes can be resolved at the mediation stage if you have a skilled and effective mediator. But, if you can’t and you must go to arbitration, it really does make a difference if there is an appeal procedure.

For my client with international customers, we instituted this 4-level system of dispute resolution: negotiation, mediation, arbitration, and appeal from an arbitration.  It is very close to a traditional judicial system. But, in this case, we are dealing with companies from different countries with different sets of laws regarding commercial relationships. The tiered system has a set of rules that accepted across boundaries. The arbitration body has a set of rules that can be followed, and everybody knows the rules.

Ultimately the lesson that came out of these examples this week is that when you’re negotiating a contract don’t make assumptions when it comes to litigation, unnecessarily binding arbitration, or mediation. There are ways in which you can provide protection through a process, that don’t necessarily have to be this crazy creative thing like the case in New York.

If you have a coherent process that makes everyone comfortable, a process that has clearly thought out a series of escalating steps, then you have a dispute resolution mechanism that will advance the parties interests by protecting against the fear of the unknown. Because, when you walk into a courtroom or into an arbitration, a winner is going to be chosen, and it is very helpful if the parties at least agree that the process of picking that winner is fair.

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