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Arbitration Provisions – Do I Want One?

This is a question posed to me quite frequently by clients.  Typically it starts with, “What does that provision really mean?” and is quickly followed by “Well, do I want that or not?”  Like so many questions in the legal profession, the answer is “It depends.”

Arbitration is an out-of-court process for settling a dispute in which each group presents its argument to a neutral third party called an arbitrator who then makes a binding decision.  By default, you will find an arbitration clause in the fine print of a large majority of contract forms unless it gets deleted during negotiation.

Arbitration can be binding or non-binding, but binding arbitration (where the courts would enforce the decision) is the most common.  Arbitration can be voluntary or mandatory.  Most parties who participate in arbitration do so because of a contract provision requiring that disputes be resolved through the arbitration process.

Now to the most important part, do you want to arbitrate?  Arbitrations are often much faster than traditional litigation, are more cost effective and typically have less of the hostile feel that can come with a public courtroom litigation.  In addition, if the topic of dispute is very technical or specific, then the parties can agree in advance on a particular arbitrator with specific knowledge in that area.  However, arbitration can have significant negatives as well.  Binding arbitration cannot be appealed or set aside unless a party can show a clear bias or violation of public policy.  In addition, there is no automatic right to obtain information from the other party as there is in traditional litigation.  Finally, the upfront costs of arbitration are significant and although we typically think of arbitration being less expensive overall, that is not true.

To illustrate regarding fees, the filing fees to arbitrate a $250,000 dispute with the American Arbitration Association (which is a commonly designated association in arbitration provisions) is $4,650.  Then add attorney’s fees and arbitrator fees in order to estimate what the overall costs would be.  By contrast, the fee to file an action in a court of law, regardless of the dispute amount, is about $350 depending on the court.  Obviously there will be attorney’s fees in addition to that as well and usually in a trial the attorney’s fees will get higher simply by virtue of the length of the trial.  Keep in mind that both an arbitrator’s final award or a final court order may assign the burden of paying attorney’s fees, the amount of the judgment, and/or other costs to the appropriate party.

Sitting down with an attorney and discussing the contract specifics and potential for disputes is the best way to make an informed decision about whether to include a mandatory arbitration provision in your contracts and more importantly how that provision should be drafted.

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