The Four Keys of Small Business Contract Arbitration

What small business owners need to know when considering arbitration as an option.

Editor’s note: This is part six of the continuing series on contract law for small business owners. Here are parts one through five: Small Business Contracts Part I: A Different Perspective, Contracts Part II: Laying the Groundwork, Contracts Part III: The Role of Legalese in Contract Drafting, Supplier Contracts- What Small Business Owners Need to Know, Contracts Part V: 7 Unique Features of Distribution Contracts

The standard procedure for resolving legal disputes is to file a lawsuit in a court of law. But a very common alternative to courtroom litigation is arbitration. 

In this article, we will consider why arbitration is sometimes preferred over litigation in court; the downsides to arbitration proceedings, and why the drafting of arbitration provisions contained in agreements should be done with care.

Here are the four keys of small business arbitration:

1.   Arbitration Presents a Contractual Alternative to Standard Litigation

Arbitration is solely a creature of written contract. Unless a party subscribes to an agreement containing an arbitration provision (also called an arbitration clause), it cannot be forced to arbitrate. 

On the other hand, should a party file a lawsuit in express violation of an agreement containing an arbitrate clause, the other party or parties to the agreement can intervene in such proceeding to compel the offending party to arbitrate.  

2.   In Many Circumstances Arbitration is Preferred over Standard Courtroom Litigation

Among the reasons that parties choose to arbitrate is that arbitration is thought of as being less costly and more expeditious than litigation in a court of law; arbitrators can have more experience than judges in handling certain types of disputes requiring special knowledge; and arbitrations, generally, benefit parties in being confidential proceedings.

Arbitration provisions can also be crafted to provide the parties flexibility in fashioning rules to govern their dispute, such as eliminating the right to trial by jury, shortening the statute of limitations of certain claims, affording the shifting of costs and expenses, including reasonable legal fees, in favor of the prevailing party.

In international commercial contracts, parties almost always choose arbitration as the preferred method of dispute resolution because international conventions make it easier to enforce arbitration awards than judgments rendered in a court of law.

3.   But there is a Downside

Although it is true that courtroom litigation can end up being quite expensive, arbitrations can also be expensive. Initial filing fees, depending on the size of the claim or counterclaim, can run thousands of dollars.

Arbitrator fees can run into hundreds of dollars an hour, and three arbitrator panels can run into thousands of dollars an hour. Although arbitrations, generally, involve a more truncated period of discovery, complicated commercial disputes may warrant full blown discovery, involving, among other things, document requests, notices of admissions, and depositions, which can draw out a proceeding for many months and, sometimes, years.

Arbitrations lasting many years are rarer than in court proceedings, but it is not necessarily vastly more cost effective or efficient. Like in the case of court proceedings, the experience litigants have may depend considerably on the demeaner and experience of the adjudicator. 

Another downside is that arbitration may not present an even playing field for all litigants. Industry arbitrations before regulatory bodies, such as the Financial Industry Regulatory Authority, may be less comfortable for non-industry players.

Moreover, arbitration provisions have become extremely common in adhesion contracts between customers and utilities in which the former are compelled to accede to agreements containing arbitration provisions that can severely restrict or even eliminate the customer’s right to trial by jury, or to file a class action claim.

In recent years, employees have more frequently found themselves bound to litigate their claims against their employers in an arbitration proceeding, in which they have been compelled to waive their right to trial by jury and other rights common in courtroom litigation.

While there has been some recent push back on enforcing arbitration provisions in circumstances where there was an imbalance in bargaining power, over all, the courts have enforced such provisions.

Next-  #4 Arbitration Clauses Need to be Drafted with Care and Takeaway