Is an arbitration clause good or bad to have in your contract?
A contract arbitration clause is a method of "alternative dispute resolution" whereby the parties to the contract agree that their dispute will be resolved by arbitration rather than through the court system. Simply put, arbitration is an informal hearing before a neutral third party, often a retired judge or lawyer, where the arbitrator hears each side's evidence and decides the outcome of the dispute. Arbitration has been en vogue for several years, the claimed advantages being generally stated as follows:
- Arbitration is quicker, and therefore saves time and effort;
- Arbitration is less intense and painstaking, and therefore saves attorneys' fees.
Arbitration clauses are often also put into consumer contracts by big companies, the thought being that it avoids the need for a jury trial, where the jury tends to favor the little guy and hammer on the big, heartless corporation.
Another common place to find arbitration clauses is in the forms created by the Minnesota Association of Realtors for use in residential real estate transactions. The forms generally ask the parties to agree to arbitration if they so choose.
However, arbitration also has many disadvantages, such as the following:
- The parties must pay an arbitration filing fee based upon the size of the claim at issue. This could be anywhere from a few hundred to several thousand dollars, depending on the size of the claim. In the court process, the filing fee is always about $250, regardless of the size of the claims in the lawsuit.
- The parties must also pay for the arbitrator out of their own pockets (generally by the hour to the tune of $250-$500/hour). Some contracts even call for a panel of 3 or more arbitrators, which triples this cost. In the court process, the judge and jury are free.
- In arbitration, the right to conduct "discovery" is limited, so the parties often don't have the ability to learn the other side's dirty secrets as well as they might in the court process.
- In arbitration, the arbitrator's decision is usually binding and final, and there are very limited options for appeal of the decision if a party thinks it is incorrect. In the court process, the losing party always has the right to at least one appeal to the Court of Appeals.
- In arbitration, arbitrators often try to reach a resolution that "splits the baby" to some degree so that there is not a clear winner or loser. This can be frustrating to a party who believes they are the clear winner. The court process is more likely to reach a decision resulting in a clear winner and loser.
- If the arbitration clause is imposed upon a consumer by a corporation's contract, the contract will often force the consumer to arbitrate in an inconvenient location (i.e. a far-away state). Travel expenses will usually make it impossible for the consumer to cost-effectively participate in the arbitration.
Although the parties to an arbitration might spend less in attorneys' fees, those savings can be overshadowed by the arbitration filing fees and the hourly fees of the arbitrator. Moreover, any overall monetary savings with arbitration are generally outweighed by the loss of procedural safeguards inherent in the court system that are not present in arbitration, such as thorough discovery and the right to appeal. In a majority of cases, I tend to advise clients that an arbitration clause is probably not in their best interests.