Enough With Arbitration Provisions: Litigators Hate Them and GCs Should Too
Arbitration provisions are a common feature of commercial transactions for businesses trying to alleviate the burdens of litigation. In-house and transactional attorneys routinely include arbitration provisions in all flavors of commercial agreements. To put it bluntly: please stop. The professed benefits of arbitration in commercial cases are frequently overstated. Proponents of arbitration argue that it is cheaper and faster than litigation with “expert” arbiters rendering final decisions. Careful examination of these claims suggests that they are an unpersuasive justification for a process that should not be incorporated wholesale into every transaction. This article examines four of the most common justifications for arbitration and suggests examination of the knee-jerk impulse to include arbitration provisions in commercial agreements.
Arbitration is Cheaper
The first fallacy of arbitration proponents is the claim that arbitration is cheaper than litigation. Not true. For a nominal filing fee, litigants can access the full infrastructure of the state and federal court systems. The cost of the judges, law clerks, administrative staff and the court house are all subsidized by taxpayers. Arbitrators charge by the hour, the arbitration provider often charges by the size of the claim and the parties may have to pay a room charge. In practice, it is difficult to complete a single arbitrator arbitration of any size for less than $25,000 in costs. Despite the financial realities of arbitration, attorneys routinely include arbitration provisions that require a three-arbitrator panel in contracts even where the amount of the transaction is likely less than the costs associated with paying the arbitrators.
Proponents of arbitration also claim that legal fees are less when compared with the costs associated with a trial. There is nothing to suggest, however, that an attorney preparing to appear before an arbitrator can prepare any less thoroughly than an attorney representing a client at trial. Moreover, the “arbitration-is-cheap” folks also tend to overlook the possibility of significant litigation associated with getting a case into arbitration. Although courts favor arbitration, such preference must yield to the agreement of the parties as expressed in the arbitration provision. It is not uncommon to litigate the scope and validity of an arbitration clause as a prelude to submitting the case to arbitration. The Pennsylvania Rules of Appellate Procedure make an order denying a motion to compel arbitration or granting a stay of arbitration immediately appealable by right. Arguing about whether a claim is subject to arbitration and the terms of such arbitration invites a sideshow that can easily dissipate any cost savings realized by the decision to arbitrate.
You Get a Highly Qualified Subject Matter Expert
A common justification for commercial arbitration is the notion that the arbitrator will be a “subject-matter expert” – one that will clearly do a better job than a judge or jury that has no similar expertise. The ideal “subject-matter expert” is a person experienced in deciding cases who can make intellectually honest, clear and decisive decisions. Most arbitrators are lawyers with little subject matter expertise except in the law. Lawyering skills are not necessarily congruent with judicial skills; claiming that they are overlooks the skills and temperament required of a judge and the time it takes to develop them. Crafting arguments and evaluating arguments are not the same thing.
While the “expertise” of lawyer-arbitrators may raise doubts, there are situations in which a specialized expertise – beyond familiarity with the law – may be warranted. It may be more efficient to resolve a dispute with a securities broker in front of a panel that already understands how securities work. Even if a specialized subject matter arbitrator is warranted, such experts may be difficult to find. Successful industry specific experts are often working in their industries, not serving as arbitrators.
Most commercial litigation, however, does not fall into this category. Commercial litigation comes in a variety of flavors – contracts, fiduciary duties, “business torts” – with widely varying facts that are not easily susceptible to a standardized response. Such cases are commonplace in both the federal courts and Philadelphia’s Commerce Program and judges and juries have resolved them for hundreds of years. Judges and juries can provide a sense of the reasonable expectations or behavior of the parties in similar circumstances. Although there are always (usually well reported) examples of juries doing crazy things, juries get it right most of the time. Commercial disputes can be complicated but the best litigators find the common-sense proposition in complicated fact patterns and convey it in a way that provides context and relevance.
Arbitrators are also subject to certain pressures that judges are not. Professional arbitrators make money by conducting arbitrations. Leaving one party totally defeated at an arbitration reduces the odds of any repeat business from the losing attorney or their friends. It also brands the arbitrator with being plaintiff or defendant friendly, further reducing the odds of future appointments. This is not fair to the arbitrator who has diligently applied the law to the facts but it is the state of the world. As a result, many arbitrators tend to “split the baby” when it should not be split.
Discovery is Less Painful
The next purported benefit of arbitration is that discovery is shorter and more efficient, thereby achieving cost savings and a prompt resolution. There is nothing about arbitration that suggests that the parties will employ “discovery lite.” Many commercial disputes simply require elaborate discovery. There is nothing inherent in the arbitration process that reduces the discovery grind. Discovery can be just as contentious in arbitration as it is in litigation, or perhaps even more so due to the lack of detailed rules of civil procedure.
In litigation, judges have the power to limit the scope of discovery to prevent undue hardship, harassment or delay. Even before the 2015 amendments to FRCP 26, both state and federal judges engaged in a “proportionality” analysis when evaluating discovery requests. Without the benefit of detailed rules of civil procedure, the scope of discovery in arbitration depends in large part on the discretion of the arbitrator. In the event of a dispute between the parties on the scope of discovery, arbitrators may choose to look to the rules of civil procedure, his or her own experience or anything else. There is nothing to prevent an arbitrator from allowing wide-ranging, multi-round discovery, increasing costs for all parties.
Attorneys in the “discovery-is-a-breeze-in-arbitration” group sometimes fail to appreciate the additional annoyance associated with compelling unwilling third-parties to produce information or dealing with an opponent’s unwarranted machinations. Arbitrators lack a court’s power to compel compliance with third-party subpoenas. As a result, extracting information from a third-party often requires the initiation of litigation anyway. Although arbitrators have some ability to punish parties who do not participate in discovery in good faith, many arbitrators are reluctant to do so.
Forward thinking corporate counsel may try to avoid such discovery tsunamis by including parameters for discovery within the provisions authorizing arbitration. But limitations that seem like a good idea when drafting an agreement can backfire if your client is the one that needs the deposition or the e-discovery to advance or defend their case. Given the extremely liberal pleading procedures that the arbitration rules provide, there is often an enhanced need for discovery in arbitration that makes any contractual limitation on the scope problematic.
Arbitration is Final
The finality of arbitration is often touted as one of its benefits. This justification is based on the unsound premise that finality is always desirable. It is only desirable if you are happy with the result or the costs of continued litigation is likely to eclipse the eventual outcome of the litigation. A party that has lost because of an arbitrator’s error has cause for concern about the finality of the proceeding; elimination of a right to appeal merely adds salt to the wound. In recognition of the perceived unfairness of such an outcome, the AAA rules now contemplate that parties may agree to make an arbitration award appealable to another panel of arbitrators.
Even absent an explicit appeal provision, a disappointed party may attempt to set aside an arbitration award by showing arbitrator bias, fraud, obvious miscalculation and other narrow categories of complaints. Although overturning the arbitration decision may have poor odds of success, the appeal may be disruptive and costly to the non-appealing party. If a trial court elects not to set aside the arbitration decision, the disappointed party may seek to appeal from that decision. Thus, a disappointed party in arbitration has two chances to set aside an award – first to the trial court, then to the intermediate appellate court – before it reaches an appellate court with discretionary jurisdiction. Conversely, a party that began its litigation in the court system has typically only one appeal before it reaches a court with discretionary jurisdiction.
The Take Away
Arbitration is not always inappropriate for commercial disputes. Confidentiality, speed and other justifications may make it the preferred method of dispute resolution in certain circumstances. It is equally true, however, that arbitration does not always performed as advertised. It is sometimes more expensive, less efficient and less effective than it might initially be intuited. A thoughtful and deliberate comparison of the costs and benefits of both arbitration and litigation will lead to more efficient dispute resolution that better serves the interests of all parties.
Reprinted with permission from the June 20, 2018 issue of The Legal Intelligencer. © 2018 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.