What Should be Included in an Arbitration Clause Used in Business Contracts?
October 10, 2022 | Joan M. Quade
Many companies are choosing arbitration to resolve business disputes, as litigation has become more and more expensive, and it sometimes takes years to get to trial. The district courts are still very behind from the COVID pandemic, adding to the delay. Even after trial, the appeals can go on for years, costing additional resources and time.
So, what do you put into an arbitration clause that accomplishes what you want? First, you should always consult with your attorneys based upon your particular business needs. They can draft the perfect arbitration clause for you, after discussing your business goals and philosophy about dispute resolution. Some companies need or want to take a more litigation-like approach regarding disputes and want a requirement to arbitrate because of its cost savings and speed, but also to include some rights to limited discovery in the process. Other businesses take a more collaborative, problem-solving approach to reach a mutually beneficial and economical resolution to problems. They want a requirement in the clause to attempt to resolve any disputes before they file for arbitration, through settlement efforts or even mandatory mediation. If the collaborative, problem-solving method does not work, they want to streamline the dispute resolution through a well-defined arbitration process. Both philosophies need specific clauses that spell out the process they want to use.
As an advocate for over 35 years representing companies in litigation and in arbitrations, and in being an arbitrator for the last 5 years, I have seen many arbitration clauses. Some arbitration clauses are very bare bones and just indicate that the parties to the contract agree to take any matters to binding arbitration. The process is then controlled by the Minnesota Uniform Arbitration Act, Chapter 572B.
The Minnesota Arbitration Act, Chapter 572B provides guidance for the process, but when disputes occur over the process, especially in selection of the arbitrator, the statute allows the parties to go to court and have the court set the process. The Uniform Arbitration Act is very helpful but the goal in arbitration is to avoid the costs and delays in the court system. So, this process of needing to go to court regarding the details of the arbitration should be avoided as best as possible through a well-crafted arbitration clause.
Some arbitration clauses are very detailed and indicate exactly how the arbitration process will be handled. Others are tailor made for the business, with just the right details. I don’t recommend a bare bones arbitration clause. It ends up costing the parties more time and money. The whole point of selecting an arbitration process is to create that efficient and cost-effective process, so outlining exactly how that will occur is very important. I recommend a tailor-made arbitration clause with specifics.
Since specifics are important in an arbitration clause, you want to dictate a process first for selecting an arbitrator that is not unnecessarily expensive. I have seen arbitration clauses that dictate that a three arbitrator panel will be selected. How it works is that one arbitrator is selected by each party and the third is selected by the two arbitrators already selected. This method of having a three arbitration panel works well but is one of the most expensive. In such a case, in any hearing that is held using this method, the parties are each paying their own attorneys to represent them, and the parties are splitting the cost of three attorney arbitrators to hear the evidence, meet and confer afterwards and draft and disseminate the opinion. This is a very costly method and adds up very quickly. To use this method, you would have to anticipate that any disputes would involve an amount to support these kinds of costs and fees. This method should be reserved for only very specific circumstances involving complex issues and a large amount of money at issue.
The process of selecting an arbitrator is important and affects the cost and timing for the dispute to be resolved. It does no good to use arbitration to attempt a more efficient and economical resolution, only to choose details, such as a three arbitrator panel for the process discussed above, that costs as much or more than litigation and may take just as long. So, for most arbitration clauses, for most companies, selection of a single arbitrator is going to be the most appropriate. That can easily be done by adding language to the arbitration clause that indicates that the arbitration will be conducted through the American Arbitration Association (AAA). The AAA trains and selects arbitrators for all types of disputes, including but not limited to Commercial cases, construction, and consumer cases and a fast-track procedure for smaller cases too! They have a rigorous selection and training process for their arbitrators, and they not only use this selection process to provide the most appropriate arbitrator for the specific type of dispute, but they have the case type specific AAA rules to follow for the entire arbitration process. Referring to and then requiring the use of the AAA rules through the arbitration clause, provides a time proven process to keep the arbitration fair, efficient and cost effective for everyone involved.
The arbitration clause can provide the venue for the arbitration hearing. It would be written into the agreement that any arbitration will take place in the city where the company does business. For example, it can provide that any arbitration will take place in the city of Minneapolis, Minnesota. The venue can only be changed by agreement of the parties later.
If a company wants to have a more collaborative problem-solving approach, it can also be written into the agreement that prior to any arbitration demand, the parties must meet and confer and attempt a resolution of the issues. It could also include the requirement to go to mediation prior to any demand for arbitration. If after a dispute arises, the parties may, by agreement, skip this step if they believe such an action would be futile. However, I have been in many mediations over the years where I believed there was no chance it would settle in mediation and yet it did. I have been surprised many times over the years. Therefore, I always encourage a discussion or mediation, in the early phases of the dispute, to see if things can be resolved before everyone spends a lot of money and time.
If arbitration is needed, the AAA arbitration rules for conducting the process, provide for an exchange of information between the parties, but actual discovery is not allowed unless the Arbitrator believes it is needed for a full, fair, but efficient hearing and orders it. This is also followed by private arbitrators using the Minnesota Uniform Arbitration Act or the Federal Arbitration Act. Generally, depositions which are a costly process of examining the other side’s witnesses under oath and with a court reporter present, done usually for litigation cases, are not allowed in arbitrations unless ordered by the arbitrator. Such orders would be very unusual, as the entire point of arbitration is to streamline the process and not allow parties to outspend each other. However, I have been involved in arbitrations over the years when some discovery and depositions were appropriate and done by agreement and/or order of the arbitrator.
If in consultation with your attorney you decide that it would be beneficial for your business to conduct some limited discovery if a dispute occurs, you can include that detail in the arbitration clause. It would indicate that certain specified discovery would be allowed. For example, the clause may indicate that in any arbitration proceeding each party must exchange all information to be used at the hearing (standard for any arbitration) and then add that each party may request additional information from the other party, and limit it to 5 document requests, for example. As usual, if any party attempts to abuse the 5 document request rule, by making the requests too lengthy or asking for information that is privileged or too onerous to collect, or irrelevant to the dispute, the arbitrator will have the power to limit or quash such requests. Some companies write into their arbitration clause that discovery will be allowed in any arbitration pursuant to the Rules of Civil Procedure. In that case, discovery is allowed.
These additions of potential discovery must be carefully drafted as not to lose the benefits of arbitration, to obtain resolution of disputes more quickly and at a reasonable cost but have a full and fair process. Experienced arbitrators are skilled at evaluating and deciding issues of discovery and what is really needed to be exchanged between the parties to properly bring and prove the claim and to defend a claim. Providing some limited additional options for discovery and exchange in the arbitration clause can work if properly drafted but letting the AAA rules and the arbitrator control discovery works very well for most cases, because the AAA rules have been used for many years and are very well time tested.
In arbitration the use of dispositive motions, like Summary Judgment can also be brought, but are very rare. A party must have permission from the arbitrator to bring such a motion. The party must convince the arbitrator that the motion is likely to succeed and that it will dispose of or narrow the issues in the case. This is required under the AAA rules and most private arbitrators would follow a similar path. In litigation, such motions are brought in most cases and can be very costly. The arbitration process only allows such motions if they are likely to be beneficial.
The arbitration clause can also indicate if the winning party must pay the losing parties attorney’s fees. This can be a very risky and expensive gamble. Including such a provision should be thoroughly discussed with your attorney in terms of the pros and cons. It can significantly change the potential financial commitment in a smaller arbitration, into a potential expensive disaster. Attorney’s fees, even in an arbitration, can reach tens of thousands of dollars and sometimes six figures.
Arbitration clauses in general are an increasingly popular choice in business contracts for any dispute resolution. Arbitration clauses can be very tailored to a business’ specific needs. Most arbitration clauses do not need to be complicated, but they do have to be well thought out. Your attorney should assist in drafting the perfect arbitration clause for your business. A good arbitration clause, that is well drafted and well thought out, is more likely to meet your company’s goals and philosophy for dispute resolution.