Seven Key Points to Consider When Using Arbitration Provisions
To the untrained negotiator, an arbitration provision may be legal “boilerplate,” which means typical clauses that require little or no negotiation – a throw-in type provision. The reality is that parties should carefully weigh the benefits and disadvantages of arbitration in every transaction, including the following points:
1. Confidentiality: Are there business secrets or other proprietary information related to the contract that you want kept confidential? Is the mere existence of the contract confidential? If there is a dispute under that contract, do you want that fact to be confidential? Do you want to be able to take positions or make statements without concern that they will be known by competitors, the marketplace, or trade publications? Are you comfortable with the other parties to the contract being able to do so? If the answer is yes to each of these questions, arbitration may be the better choice for your transaction.
*Tip: If a dispute involves a privately-held company, arbitration can generally ensure that the dispute is resolved without risking that the media (including the trade press) will learn of and publish information about the dispute and its ramifications. Include confidentiality requirements as part of your arbitration agreement. Draft the arbitration provision to limit the potential characterization of information as public in nature. Require that a settlement of a dispute must not be disclosed, with rare exception.
2. Avoidance of a Jury/ Selection of the Decision-Makers: How important is control over selection of the decision-maker? For many businesses, avoiding the risk of an adverse and expensive jury verdict is a high priority. Arbitration provides the parties with some control over the decision-makers, either by an agreement on the selection of arbitrator(s), or by the selection of two advocate arbitrators who, in turn, select a neutral third arbitrator.
If the contract involves a specialized industry, the parties may be able to agree ahead of time or during the selection process on a decision-maker with the requisite specialized knowledge. A true expert can often ascertain the nature of the dispute and resolve it without a substantial amount of expert witness input.
*Warning: It may take a long time to find an arbitrator acceptable to both sides. In certain industries, you may have difficulty finding a person with specialized knowledge who does not choose a side (such as lenders instead of borrowers) or have a professional bias (such as product liability potential of certain equipment). Do not wait to find your arbitrators until the other side begins to look if you want to find the right people to hear your dispute. The right arbitrators can save you money and grief.
3. Cost: Business people and their attorneys often believe that arbitration is a less expensive route than traditional litigation. Although arbitration may cost less in certain circumstances, in others, arbitration can cost more than litigation. For example, parties may pay substantial administrative fees associated with filing arbitrations with an arbitral organization such as the American Arbitration Association (AAA). Arbitrator’s fees themselves can be expensive, particularly if the parties use a panel of three arbitrators. In contrast, filing fees in court are nominal, and tax dollars, not you, pay for the judge’s services. Attorney’s fees may cost an equal or greater amount than a court proceeding depending on how the arbitrator conducts the arbitration.
The lack of defined procedural rules in arbitration can increase the costs in excess of those associated with traditional litigation.
*Insight Point: Federal and state courts have established rules of civil procedure and have developed precedent associated with those rules. However, each arbitration is unique to the parties and may involve some areas of uncharted procedural waters. These uncertain procedural areas can lead to tangential, and potentially time-consuming and expensive, disputes among the parties that an arbitrator will need to resolve.
4. Limits on Discovery: Do you have the information and documents necessary to prove your case, or does the other side? Consideration of this factor is important because discovery under most sets of arbitration rules is limited, much different than under the Federal Rules of Civil Procedure.
In arbitration, discovery usually refers only to a process that arbitrators can use to compel the actual parties to produce documents and appear as witnesses, and in some circumstances produce persons under their control for depositions (a question and answer interrogation under oath).
While the Federal Arbitration Act enables an arbitrator to subpoena third parties for the arbitration hearing itself, an arbitrator’s subpoena power over third parties for the purposes of discovery is an open question. Recent federal court decisions indicate that even the arbitrator’s subpoena power over third parties for the purposes of the arbitration hearing is limited to third parties within the region of the place of the hearing, thereby restricting the ability of the arbitrator to compel parties in other states to appear and testify at the hearing.
In litigation, court rules empower attorneys to use document requests, written questions and depositions to find out and develop evidence from the other side (adversary) in preparation for trial. Traditional litigation thrives on extensive and liberal exchange of information to improve the potential for a fair trial, and includes powers to force witnesses to appear in the proceedings. This process can be very expensive, but also can be helpful if the other party to the transaction holds all of the information that you need to prove your case.
The differences can be seen in the rules. The AAA Rules encourage arbitrators to limit and control discovery, while the Federal Rules encourage liberal discovery. The arbitration limitations can be a plus or a minus, depending on whether the dispute entails a pure question of law, or whether you already have all of the necessary facts or need to obtain them from the other side in order to prove or defend your case.
Additionally, through the use of an arbitration provision, the parties may be able to avoid or limit electronic discovery obligations under the amendments to the Federal Rules of Civil Procedure, which became effective December 1, 2006. Electronic discovery can be very expensive and includes the burden of recovering e-mail, documents retained in electronic form under document retention programs and other information stored in electronic media.
*Insight Point: The availability of electronic discovery could be a bane or a boon to your position, depending on the nature of any likely disputes and the kind of information you believe may be necessary to assist you in asserting your rights and remedies under, or defending any action relating to, your contract. Evaluate the nature and location of your information when you determine the scope of electronic discovery provisions in an arbitration agreement.
5. Review of an adverse decision: Does the contract involve any novel issues? Is having an appeal process important to you if the outcome is adverse? Or, is it more important to you that the dispute be resolved quickly and without further appeals?
*Warning: If you choose arbitration, the arbitrator’s word on your contract is the only word, and it is usually the last one, too. Arbitral awards are very difficult to overturn.
Generally, courts have vacated arbitral awards reluctantly and only where the award was procured by corruption, fraud or undue means, or the arbitrators were biased or corrupt. There are rare cases where a court has vacated an award for other reasons, such as where the arbitrators so exceeded the powers granted by the contract. A trial court decision on the merits (and earlier rulings in some instances), on the other hand, is generally appealable as of right and allows a party to raise a broader array of issues on appeal. Depending on the outcome, this may or may not be an advantage for you.
6. Speed of the proceeding: How important is a speedy resolution to you? Arbitration is likely to be a speedier process than traditional litigation, particularly if there are limits on the amount of time the parties can take to select the decision-maker(s). Additionally, the limits on discovery and ability to have some control over the scheduling of the evidentiary hearing can lead to a faster ultimate determination on the merits than if the matter were before a court. It also is easier to get the arbitrator’s attention on discovery and other interim disputes, perhaps because an arbitrator’s services are compensated (by you and the other transaction parties) on an hourly basis. Exceptions to the general notion that arbitration is faster than traditional litigation are jurisdictions such as the U.S. District Court for the Eastern District of Virginia [Alexandria], which maintains a “rocket docket.”
7. Enforceability of an Award Against an International Party: Are any of the parties to the contracts international? Does the contract involve any transactions that will take place abroad? Arbitral awards are enforceable in the United States and most other countries under the New York Convention. However, court awards may not be enforceable in the United States when, as is typical, the U.S. is not a signatory to any other convention enforcing foreign judgments.
Summary
The decision to use or write an arbitration provision in commercial transactions should not be made with a mechanical “one-size-fits-all” approach. It is critical that transaction parties consult with their litigation lawyers, not just their transactional counsel, and take the long view of the business relationship at hand and how the parties are going to resolve disputes. To neglect to tailor a dispute resolution provision to your needs at the outset of a transaction may lead to unnecessary disadvantage, expense and distraction down the road.
