Arbitration clauses: Should you forgo rights for cost savings?

(Editor’s note: Curtis Smolar is a partner at Ropers Majeski Kohn & Bentley. He submitted this column to VentureBeat.)

A reader asks: I am drafting contracts for vendors and I want to include an arbitration clause in each to protect myself from litigation. Should I do it?  If I do have an arbitration clause, what should it include?

Answer: An arbitration clause can give you a cost-efficient method of resolving disputes.  Because of the finality, though, you’ll want a clear, concise clause that expresses precisely how you want the process to proceed. You’ll also want it to give you some control over the process, the arbitrator’s role and limits to the arbitrator’s power.

Contractual arbitration means you are agreeing to forego your right to a court and jury trial and that a third party neutral will decide your case.  This can be beneficial for four key reasons:

• Arbitrators may be more knowledgeable.
• Arbitrators are less likely to give unpredictable results.
• Arbitrators can have specific knowledge about an industry.
• It creates finality (usually much more quickly than litigation), which is good for business.

Arbitration clauses in commercial contracts can be helpful to minimize risk.  An arbitrator is typically a retired judge or an active/retired attorney and is generally able to assess the value of a case and thereby reduce the risk of an otherwise unpredictable outcome in litigation.  Also, the cost of the actual litigation may be substantially reduced in arbitration, due to its abbreviated nature.  The downside is that you are stuck with an arbitrator’s decision, which in most cases, cannot be appealed.
Generally, an arbitrator and/or a court will be bound by the actual language of the arbitration agreement.  The arbitrator or the arbitration organization will provide “gap fillers” when the contracts do not address certain issues. So you can see why the wording of the arbitration clause is so important.

Many arbitration companies/organizations have sprung up as a result of the increased need of alternative dispute resolution services.  One is the American Arbitration Association (“AAA”), which has offices across the country and standardized rules.  (It’s important to note that the cost of the arbitration with AAA is affected by the amount of the dispute.) Another well-known arbitration organization is the Judicial Arbitration & Mediation Services, known as JAMS.  There may be other local ADR providers in your hometown as well.

Both AAA and JAMS have rules that act as gap fillers or in some cases may trump contractual language.  Read those and understand them before you incorporate their rules into your arbitration clause. And it’s a good idea to run the clause by a lawyer before presenting it, since you’re giving up your right to go to court.

An arbitration clause must include, at the very least, that the parties have voluntarily agreed to arbitration and agree there will be a third party decision maker. You also need a mechanism for ensuring neutrality with respect to the rendering of the decision, a decision maker chosen by the parties, an opportunity for both parties to be heard and agreement that the decision is binding.

You should also consider the following issues:

• The scope of the arbitration agreement (all disputes or just disputes arising out of the contract?)
• Governing law (e.g. the law of the State [or Country] under which the arbitration is to be decided)
• The venue, or actual place the hearing can take place
• Discovery (the process of getting information from the other side)
• Powers of the neutral/arbitrator
• What credentials the neutral/arbitrator should possess
• Provisional remedies (e.g. injunctions)
• The rules of the arbitration
• Form of decision (e.g. reasoned decision)
• Post arbitration remedies (Can it be appealed?)
• Allocating costs and procedures.

Arbitration can be a useful tool to resolve disputes by saving time and money on the judicial process.  But because you are giving up valuable rights, it needs to be complete, well drafted and carefully vetted.

Startup owners: Got a legal question about your business? Submit it in the comments below or email Scott directly. It could end up in an upcoming “Ask the Attorney” column.

Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.