Using Arbitration to Settle Commercial Disputes: A Look at the Pros and Cons

In the last twenty years, alternative dispute resolution, and arbitration in particular, has become a widely accepted alternative to litigation as a method for resolving commercial disputes. Arbitration is now the “go-to” method of dispute resolution in numerous industries, including construction, insurance, broker-dealer agreements, and credit card accounts.

 In many industries where arbitration is common, the requirement to submit to arbitration is embedded in a form contract; or the parties do not have equal bargaining power, so there really is no option to avoid arbitration. But in private agreements, such as shareholder agreements made between business owners or a construction contract, the question of whether or not to submit disputes to arbitration rather than litigation needs to be thought through very carefully.

So, is arbitration preferable to litigation? The short answer is: “it depends.” Here are the factors, both pro and con, to consider.

Pros: Factors Favoring Arbitration        

  • Privacy:  Arbitration is generally private. Unlike court proceedings, which are a matter of public record, arbitration proceedings are confidential. Parties in competitive industries often do not want their disputes publicized. For some, this a powerful reason to use arbitration.
  • Expertise:  Many industry-specific groups have their own pool of arbitrators, who usually have practical experience in the field where the disputes arises, such as the construction industry or securities broker-dealers. This factor may not be as important as some think, however; often, an arbitrator who comes to a dispute with a pre-existing knowledge of the industry also comes to it with a pre-existing bias. Experience in the industry does not equal impartiality
  • Speed and Efficiency:  This is often cited as a justification for favoring arbitration; but the emerging trend in recent years is to superimpose more and more of the features of litigation onto arbitration. Increasingly, arbitrations feature discovery—both of fact witnesses and experts—and motions, where the parties ask arbitrators to decide a point of law. Incorporating these features in to arbitration reduces its advantage over litigation, subtracts from speed and efficiency, and raises the costs of arbitration, especially the fees charged by the parties’ attorneys.
  • Finality:  As a general rule, an arbitrator’s decision is final. While finality and avoidance of appeals are worthy goals, appeals are there for a reason—to correct errors in the result reached at trial (or arbitration). While Frivolous appeals are a waste of resources, a party who loses in an arbitration and has a bona fide basis for appeal will rarely, if ever, be able to pursue it.

Cons: Factors Disfavoring Arbitration

  • Cost: There is a perception that arbitration is less costly than litigation; but as arbitrations take on more features of litigation, like discovery, motions, and use of experts, the cost advantage lessens considerably. If you add the cost of paying for an arbitrator’s time (often including “study time” both before and after the arbitration hearings) and use of the arbitration facilities, the arbitration quickly becomes just as expensive as litigation.
  • Not Bound by Law:  A unique feature of arbitration is that arbitrators are not bound by the law. Some people argue that this “frees” the arbitrator(s) to issue compromise rulings (a widely held stereotype about arbitrators). A more troubling aspect is that an arbitrator has the unchecked authority to decide a dispute in any way he or she pleases, without regard to legal precedent; and the right to appeal an arbitrator’s ruling is very limited. The arbitration process presents the risk of getting “stuck” with a result that is, for lack of a better word, simply wrong—in the sense that it violates applicable law. The arbitrator’s ability to decide issues without regard to legal precedent applies not just to substantive matters, but extends to procedural matters as well. This means that evidence that would not be admissible in court is usually received in evidence by the arbitrator. This is something to consider very carefully.
  •  Finality:  Not only is the arbitrator not bound by applicable procedural or substantive law, but his or her decision is final, except in rare circumstances. Generally, the only time that a court will overturn an arbitrator’s decision is where a party can prove that fraud was committed. This is an extremely difficult and rare situation. As a practical matter, you should assume that whatever the result of the arbitration, you will be stuck with it.

Whether the parties to a private agreement should agree to resolve their disputes through arbitration is an issue that should be thought through very carefully. Consider all the features, both good and bad, that arbitration offers. The features that used to make arbitration a preferred method of resolving disputes have been weakened as arbitrations become more lengthy, complex and protracted—in other words, more like litigation. Unless a party has a critical need for a dispute to be decided in private or by an expert, most individuals will usually find that litigation offers them more safeguards to ensure that their legal rights are protected, not only during the hearings themselves, but afterwards on appeal.

The Business Litigation and Debt Restructuring Practice Group at the law firm of Fellheimer & Eichen LLP.

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