by Samuel K. Darling, Business Attorney in Washington State
Should you include an arbitration provision in your contract? It depends. Lawyers for large corporations commonly include arbitration clauses in boilerplate contracts, and for good reason. If you’re reading this article, however, you probably aren’t part of a large company with easy access to lawyers. You wouldn’t be researching the topic yourself if that were the case. More likely, you’re a leader of a small or midsize business, or perhaps you’re just starting your company. This article is intended to help you – the “little guy” – determine whether to include an arbitration clause in the contract you’re drafting or negotiating.
I. How Supposed to Work. At first blush, arbitration clauses appear to be “a win-win” for everyone. They force parties to resolve any related contract disputes in arbitration, which are supposed to be inexpensive and fast. Arbitrations utilize more relaxed rules than courts, lawyers aren’t as necessary, and the process typically moves more quickly than court. Arbitration can also be more private, preventing dirty laundry from airing before a crowd. In theory, most contracting parties should prefer arbitration over traditional court proceedings.
II. How Goes Wrong. In reality, arbitration presents substantial barriers to justice for small businesses, consumers, and employees facing larger corporations. These barriers comes in at least four forms relevant to you:
1. Arbitrator Bias. On average, arbitrators favor whichever party is more likely to give them repeat business, and surveys show arbitrators are well aware who that is. Put simply, arbitrators side with large corporations more than courts do.
The fact corporations fare better in arbitration than in court is especially surprising given the rules of the two venues. Common sense suggests the less-strict evidentiary and procedural rules of arbitration should help level the playing field for disputes between Davids and Goliaths. Relaxed evidentiary and procedural rules mean little guys are less likely to lose by technicality. But apparently the difference in rules isn’t enough to compensate for arbitrator bias.
This is not to say arbitrators are corrupt. Some might be, but it seems improbable a significant percentage are. Some researchers believe big businesses excel in arbitration because the businesses know which arbitrators are pro-corporation and select them at a higher rate, a more innocent explanation than corruption.
Another plausible explanation is arbitrators side with large businesses the way sports fans route for local teams. It’s a natural and subconscious bias in favor of common interests.
Whatever the reason, corporations tend to dominate little guys in arbitration.
2. Expensive Hearing Fees. Arbitration outside the court system comes with some hefty expenses aside from lawyer fees. Whereas tax payers pay judges, the parties often pay arbitrators upwards of $300 per hour for hearings that can take days. This can be a substantial cost of entry for the average person, especially if the hearing fees exceed the amount in dispute.
3. No Class Action. On a related note, arbitration clauses often implicitly preclude class action, preventing little guys from combining their resources to fight a big guy in one case about numerous small but identical wrongs. Even if the arbitration provision doesn’t say “no class action”, it’s commonly disallowed. This can lead to astoundingly unfair results for small businesses, consumers, and employees who contract with an unscrupulous big business. For example, a few years ago a major bank opened thousands of unauthorized bank accounts, costing each affected consumer around $25. Normally consumers would file a single class action court case against such a bank. But in this instance, the consumers’ arbitration clauses prevented them from filing in court. To litigate their dispute, each consumer would have needed to initiate a separate arbitration, costing each hundreds and perhaps thousands of dollars to pursue $25 in principle damages. Few consumers would do that. The arbitration clause effectively immunized the bank against consumer recourse for low-dollar wrongdoing. The bank ended up paying the consumers back, but only after receiving immensely bad publicity nationally.
4. No Appeal. Compounding the above-mentioned unfairness, appeals of arbitration awards are much more difficult than appealing a judge’s decision. Many lawyers describe an appeal of a bad arbitration result as “nearly impossible”. A biased arbitration result almost always stands.
Notably, this isn’t true for all types of arbitration. For example, Washington State courts require parties to arbitrate certain simple categories of disputes, and appealing those arbitration results is easy. These easy-to-appeal arbitrations are sometimes called “mandatory” arbitration.
In Washington (and other US States that adopted the Uniform Arbitration Act), contractual arbitration clauses do not result in mandatory arbitration. They result in “binding” arbitration – the kind that is nearly impossible to appeal. So if you include an arbitration clause in your contract, expect to forgo your ability to appeal anything other than obvious misapplications of the law.III. When Nonetheless Want an Arbitration Provision. So do you want an arbitration clause in your contract? If you’re a large corporation, you do. If you’re contracting with someone around your own size, it’s probably a good idea to have an arbitration clause because of the decreased attorney fees usually associated with arbitrations as compared to court cases. Similarly, if you’re a small or midsize business contracting with numerous consumers, an arbitration clause will probably help you the same way it would a large corporation. But if you’re a little guy contracting with a big guy, beware.
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