When you are negotiating a contract, what is the best way to anticipate and protect yourself from a potential dispute? As common as it is to insert a simple arbitration clause, it is not necessarily the best way to go. With such a provision, you are usually limited to using arbitration only to resolve a dispute or a contract breach.
In many cases, on the other hand, going to court (as opposed to arbitration) is a more cost-effective choice. So you need to carefully consider the nature of potential disputes and how they could be resolved efficiently or, at least, with less expense.
If you decide you actually want arbitration, it can be very effective. A carefully crafted provision can prevent hassle and expense, and even provide you with a significant advantage. However, we advise our clients to consider the following pros and cons of inserting an arbitration clause into a contract:
- Arbitration entities, such as the American Arbitration Association (“AAA”), often charge many thousands of dollars just to initiate arbitration. Alternatively, the costs to initiate a lawsuit are typically less than $100 in filing fees. Due to the heavy upfront costs, once such arbitrations have been initiated they are less likely to settle than a lawsuit in court.
- The expense continues to grow because the parties pay hourly for the arbitrator’s time (usually $400 – $800/hour in the case of AAA). Alternatively, the parties to a contract dispute do not pay for the judge’s time in court.
- Arbitration decisions are typically “final.” You should presume that the arbitrator will become a dictator where rules of law may not be strictly followed. Unlike in the court system, arbitrators’ decisions are rarely appealable.
- AAA is the default arbitration organization, however, many alternatives exist. The parties to a contract have the power to designate a specific individual (or pool of individuals) to arbitrate any disputes.
- If the parties elect to restrict the dispute resolution to arbitration, it is crucial to carefully craft the mechanism and “rules.” They may include defining what type of dispute is to be arbitrated, whether the arbitration will be binding, whether discovery is allowed, what jurisdiction’s law will be used, whether the arbitrator must have an expertise, or whether the arbitration will be decided on the basis of the documents submitted (no argument/witnesses).
Arbitration clauses should never be “taken for granted.” Instead, they should be drafted with caution. While we are negotiating and finalizing a contract, you can count on us to initiate a discussion regarding arbitration so you can understand the implications and make an informed decision about the best strategy for your interests.