Commercial arbitration has become more complex, time-consuming, and expensive – in other words, more like litigation.  In Part One, we discussed the increasing skepticism among corporate counsel about the purported “better, faster, and cheaper” advantages of arbitration.  This week, we take a look inside the arbitration process – from the arbitrators’ point of view – to explore the factors driving this trend.

One major reason why arbitration is becoming more like litigation is that the arbitrators themselves are increasingly and exclusively drawn from the ranks of the legal profession.  The non-lawyer arbitrator is becoming vanishingly rare.  A recent survey of experienced commercial arbitrators found that 98% are lawyers and/or former judges – a much higher number than had been the case 15 to 20 years previously.[1]  Arbitrators are more likely to view arbitration as a full-time “profession” rather than an occasional activity, and three-fourths of them depend on their arbitral practice for additional income.  More arbitrators are competing for fewer cases, and a majority say they are getting less work than they would like to get.[2]

Another factor driving the increased cost and complexity of arbitration is the tendency of arbitrators to allow more process (such as pre-hearing motion practice, extensive document discovery, and post-hearing briefing) while failing to employ tools that can promote early resolution (such as granting early dispositive motions or encouraging settlement).  Arbitration is often praised for its procedural flexibility, but in practice that flexibility can often mean parties spend more time arguing about procedure and arbitrators spend more time dealing with case-management issues.

Cases in arbitration are more likely to proceed all the way to final hearing, because arbitrators are reluctant to grant dispositive motions (such as motions to dismiss or for summary judgment) that could potentially bring an early end to the case or at least narrow its scope.  In a recent survey, 21% of arbitrators reported that they had nevergranted an early dispositive motion, and another 70% said they had done so only rarely.[3]

Resolution by early settlement is also much less common in arbitration than in litigation.  Most arbitrators make little or no effort to encourage mediation or early settlement, and many of them believe that is simply not part of their job.  One arbitrator even complained that settlement prior to final hearing “causes havoc” to his schedule and results in “lost income” from other cases he turned down.[4]  In the 2011 CCA survey, only 15% of arbitrators reported that the majority of their cases settled prior to the final hearing – an astonishingly low number compared to the over 95% of civil lawsuits that settle before trial.   More than half of arbitrators said that they “never” concern themselves with encouraging settlement, many believing that such an approach would conflict with their duty of impartiality and their responsibility to see the arbitral process through to its end.[5]

The result of arbitrators’ tendency to allow more process while not promoting early resolution is that, in many cases, arbitration has become more expensive and time-consuming than litigation.  A 2012 study found that, on average, parties in arbitration incurred attorneys’ fees and related costs 31% higher than they would have incurred in equivalent court litigation.[6]  In former years, an arbitration might take six months “cradle to grave.”  Today, however, the fastest way to resolve a case may be before a jury, because – unlike paid-by-the-hour arbitrators – “they want to go home.”[7]

Separate and apart from the increased time and expense, modern commercial arbitration can also entail considerable uncertainty and risk.  The same procedural flexibility that makes arbitration attractive also makes it unpredictable.  Arbitrators are typically free to consider hearsay and other evidence that would not be admissible in court, and the vast majority of them do so.[8]  The limited scope of judicial review can exacerbate the harm done by a bad evidentiary ruling.  An arbitrator may exclude highly relevant evidence that is essential to a party’s case, or even order the disclosure of privileged documents to the opposing party.  Unlike in a court, the aggrieved party has no recourse to mandamus review.

The outcome of an arbitration is not necessarily more predictable or reliable than a court’s verdict.  Survey evidence lends some credence to the common stereotype that arbitrators are prone to make “split the baby” compromise awards even when the facts and the law clearly favor one side.  Commercial arbitrators who serve on multi-arbitrator panels report that they “almost never” dissent from the panel majority, and 90% say they negotiate with the other panel members over the amount of the award.[9]  This predisposition toward compromise can raise costs by giving more bargaining power to parties with weak (or even plainly meritless) claims, because the party with the stronger case cannot be certain of beating those claims quickly or cheaply.

At the other extreme is the risk of a “runaway arbitration” in which the arbitrator, guided only by a sense of fairness, makes a massive award against the party he or she believes is in the wrong.  Between one-fourth and one-fifth of arbitrators freely admit that they sometimes render decisions based on their “sense of equity and fairness” even if the result is contrary to the law.[10]  Arbitrators are less constrained to follow the law, because their decisions will almost always be upheld on judicial review even if they get it badly wrong.  The grounds for challenging an arbitral award in court are extremely limited,[11] and the U.S. Supreme Court has held that parties cannot agree to expand the scope of judicial review.[12]  Even if the parties wished it to, a court cannot overturn an arbitrator’s decision on account of clear legal error or a grossly excessive award.  A court challenge is highly unlikely to succeed – and it may even make things worse, because some courts will impose sanctions on “losers” who bring “frivolous” challenges to arbitration awards.[13]

The combination of unpredictability and unreviewability makes arbitration a particularly risky choice for high-stakes “bet the company” disputes.  Several companies have learned this lesson the hard way:

  • In 2009, an arbitrator ruled against iFreedom Communications in an employment dispute with its chief marketing officer. The arbitrator awarded $4.1 billion against the company, nearly $3 billion of which represented punitive damages.  The award was upheld in court.
  • In 2013, an arbitrator awarded $2.76 billion to Kraft Foods in a contract dispute with Starbucks – an amount that exceeded Starbucks’ total profits for 2011–2012.
  • In 2014, an arbitrator awarded Swatch $449 million in a dispute over a failed partnership with jeweler Tiffany – an amount that exceeded Tiffany’s total profits for 2012.[14]

The risks and disadvantages of arbitration are serious, but they are not insurmountable.  Many of these problems can be avoided or mitigated – and the “better, faster, cheaper” promise of arbitration can be realized – by careful and thoughtful drafting of arbitration agreements.  Our next article on the Fish Litigation Blog will discuss the “best practices” that can make arbitration work.