ARBITRATION CLAUSES IN CONTRACTS

Should you include an arbitration clause in your contract?

Arbitration is an out-of-court proceeding in which a neutral third party called an arbitrator hears evidence and then makes a binding decision. Arbitration is the most commonly used method of alternative dispute resolution. The American Arbitration Association formally conducts the arbitration process, but arbitration can be done by agreement as well. Arbitration resembles a court proceeding: each side calls witnesses, presents evidence, and makes arguments. You can find an arbitration clause in the boilerplate of all kinds of contracts these days. I recommend an arbitration clause for certain clients in the right situation.

Binding or Nonbinding Arbitration

Arbitration can be binding (which means the participants must follow the arbitrator's decision and courts will enforce it) or nonbinding (meaning either party is free to reject the arbitrator's decision and take the dispute to court, as if the arbitration had never taken place). Binding arbitration is more common. In general, I would not recommend a non-binding arbitration. In those instances I would prefer a non-binding mediation in which a neutral third party tries to help the parties reach a settlement.

Who Can Arbitrate Disputes?

Arbitration can be voluntary by written or verbal agreement or mandatory. Most contract arbitration occurs because the parties included an arbitration clause which requires the parties to arbitrate any disputes "arising under or related to" the contract. If an arbitration provision is not included in the contract, the parties can still arbitrate if they both agree to it. It is less common to reach an agreement to arbitrate once a dispute has arisen if it is not already in the contract.

Advantages and Disadvantages of Arbitration

Advantages. Most important for many companies and individuals, arbitration is private. The decisions and your dirty laundry do not become public record. Arbitration is usually faster, simpler, more efficient, and more flexible for scheduling than courthouse litigation. Arbitration also avoids some of the hostility of courtroom disputes because you avoid the public drama of the courtroom. If the subject of the dispute is technical, for example, about an architectural drawing, the parties can select an arbitrator who has technical knowledge in that field, rather than a judge who may not be familiar with the issues.

Disadvantages. Unlike a court ruling, a binding arbitration ruling cannot be appealed. It can be set aside only in rare instances, like if a party can prove that the arbitrator was biased or that the arbitrator's decision violated public policy. Also, there is no automatic right to discovery so you may be in the dark on a lot of facts before you get to the arbitration. You can include a requirement for discovery in your arbitration clause or agree to it under arbitration rules. The costs and risks of arbitration can be significant; in some cases, they may even exceed the costs of litigation.

The Cost of Arbitration

The cost and regular filing fees of the American Arbitration Association for initiating an arbitration is significantly higher than the cost of filing a lawsuit. Arbitration filing fees are typically thousands of dollars and court filing fees are hundreds of dollars. In addition, the parties in the dispute pay the arbitrators, and arbitration fees can easily run to $10,000 or more. On top of that you still have your administrative costs and attorney fees. So if you are a company that can afford it and you are contracting with individuals that cannot, it is probably a big advantage to include an arbitration clause.

Sample Arbitration Clauses

If the contractor wants to include an arbitration clause, below are some examples. Example 1 shows a simple clause; Example 2 offers more conditions and obligations. A good rule of thumb to follow is that the complexity of contract clauses should be commensurate with the amount of money at stake if the contract is breached.

EXAMPLE 1

Arbitration. All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of Iowa.

EXAMPLE 2

Arbitration. All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of Iowa. The arbitration shall be conducted on a confidential basis pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Any decision or award as a result of any such arbitration proceeding shall be in writing and shall provide an explanation for all conclusions of law and fact and shall include the assessment of costs, expenses, and reasonable attorneys' fees. Any such arbitration shall be conducted by an arbitrator experienced in [insert industry] and shall include a written record of the arbitration hearing. The parties reserve the right to object to any individual who shall be employed by or affiliated with a competing organization or entity. The parties shall be entitled to discovery as under the Federal Rules of Civil Procedure. An award of arbitration may be confirmed in a court of competent jurisdiction.

Contact Jeana Goosmann

Goosmann Law is available to help clients draft contracts, analyze arbitration clauses, and represent clients in the arbitration. If the arbitrator's decision is binding, you only have one chance to win. Goosmann Law: Strategic thinking on your side. Contact Jeana Goosmann today at (712) 226-4000 or Jeana@Goosmannlaw.com