Santa Barbara Business Litigation Alert� Negotiating Arbitration Clauses in Your Contracts

Introduction

 

When you enter into a new contract with a client or customer, significant time and effort is typically expended on negotiating the “usual things”—e.g., scope of services, schedule, and price. But what happens if there ends up being a dispute over the job? This part of the contract is often not given as much attention on the front end, but could end up having significant ramifications for you on the back end.

Most business professionals utilize Arbitration as their “standard” method for dispute resolution. But does it really make sense for you to arbitrate rather than go to court?

 Three points to consider:

1.  Is Arbitration preferable?

2.  What are the differences between the two major Arbitration providers?

3.  What should your Arbitration Clause look like?

 Is Arbitration Preferable?

 In the last 10 -20 years, arbitration has become very common for resolving legal disputes. But is it right for your situation? Despite what you may have heard, this is a very complicated question. Arbitration has some significant advantages over a court action. But there are dangers as well. Do your homework before deciding to sign a contract that contains a mandatory arbitration clause.

 There are some advantages to arbitration. The process generally lessens the hostility-the parties will have to work together. The process is generally cheaper usually. The money you pay an Arbitrator needs to be weighed against the greater scheduling predictability afforded by the Arbitration.

 The arbitration process is also generally faster…usually. The two major Arbitration providers are far more time sensitive than in the past, and are working harder than ever to move cases along. Compare that with the time it takes to get to trial. California budget issues and court funding issues are not likely to get better. A five day Arbitration can equal a twenty day Trial in terms of time actually spent putting on your case.

 The Arbitration process is also generally more flexible in terms of timing. A trial has to be worked into a crowded court calendar. In contrast, for an Arbitration, you set the date and place of hearing, including weekends and evenings. You will get more time and attention…but pay for the privilege.

 The evidence rules are also generally simplified in an Arbitration. The often confusing California evidence rules generally do not apply in arbitration proceedings. Who testifies, what they testify to, what documents will be used, what documents are needed-these issues are typically handled by a phone call, not with what is known in Court as “discovery”  This generally leads to more confidence that you will actually be able to put on your entire case.

 A further advantage is that an Arbitration proceeding is generally private. A court trial is a public proceeding. An arbitration is not. You may or may not be able to make the contents of an arbitration proceeding confidential, but the hearing itself won’t be out there for the world to see.

 These are some of the advantages. But there are potential downsides as well.

 First, the Arbitration ruling is generally final. If the Arbitrator’s award is unfair, illogical, or even contrary to the law, you will likely be stuck with it. There are very limited ways to get an arbitration award thrown out. Weigh this against the practical reality that an Arbitrator will probably spend as much or more time crafting the opinion than a Judge. That’s a function of both time (the Court doesn’t have a lot of it) and money (the Arbitrator is paid by the hour.)

 Another potential downside is the lack of transparency. The Arbitration hearing is generally in private. The decision is usually not publicly accessible. This may or may not be a bad thing, but it potentially increases the risk of a tainted or biased process.

 Finally, arbitration is getting to be less of a bargain. As a general rule, arbitration is cheaper than court resolution. But this is not as clear anymore. Costs to initiate a case are higher.

You have to pay the arbitrator’s fee, and administrative fees can be steep.

What are the differences between the two major Arbitration Providers?

Let’s say you decide you want to arbitrate. What’s the next thing to think about?

The two most often used arbitration forums in the United States are:

1.  AAA (American Arbitration Association); and

2.  JAMS (Judicial Arbitration and Mediation Services)

There are important distinctions between the two. It’s important to have a basic understanding of some of the main differences before you commit to one or the other in your contract. Three issues to consider are the scope of discovery, entitlement to attorneys’ fees, and confidentiality of the process.   

Discovery under the AAA is potentially broad scope, but what the rules say is different than what is happening as a practical matter. When it comes to documents, the arbitrator may, on application of a party or in the arbitrator’s own discretion, require the production of documents:

        1.  On which a party intends to rely

         2.  That are relevant and material to the outcome of disputed    issues if sought in a document request. (Rule R-22(b))

 With respect to Interrogatories, the new AAA Rules do not mention Interrogatories. Former rules provided for them only on a showing of good cause. That doesn’t mean the Arbitrator will not order them, but it is an increasingly tough sell.

With respect to Depositions, AAA Rules generally allow them, but it is important to understand what is happening as a practical matter. The Arbitrator does have discretion to allow them. (Rule R-21) The AAA’s Complex Commercial Rules allow for depositions in “exceptional cases”, “at the discretion of the Arbitrator” and “on a showing of good cause.”   (Rule L-3(f))

 The AAA Arbitrator has broad authority “to order and control the exchange of information, including depositions.” The Arbitrator may also allocate the cost of taking the deposition. (Rule L-3(f)) As a practical matter, however, depositions are discouraged in the AAA setting. Depositions are no longer even mentioned as an agenda item for the Preliminary Hearing. This is a modification of an earlier AAA Rule that references as an agenda item whether sworn statements or depositions may be introduced.

JAMS discovery rules are somewhat more limited in scope, technically. Document requests must be limited to documents that are directly relevant to significant issues in the case or in the case’s outcome. (JAMS Discovery Protocols at 3). This is a more restrictive standard that the AAA, and more in accord with the Federal Rules of Civil Procedure on this issue (FRCP Rule 26(b)(1))

The JAMS rules do not mention Interrogatories. If the parties agree they should be used, they will likely be used. Otherwise, it will probably not be allowed.

When it comes to depositions, JAMS Rules are restrictive. JAMS Rules allow one deposition per party. The Arbitrator may order more. (Rule 17 (b)) JAMS has “streamlined” rules that do not even allow for the taking of a deposition unless there is a significant showing of good cause, including demonstrating that there is no other way to get the information.

Attorneys’ Fees are subject to broader discretionary rules with AAA than with JAMS.

In a AAA Arbitration, the Arbitrator may award attorneys’ fees if EITHER:

 1. Both Parties request an award of attorneys’ fees;  OR

 2. They are provided for in the contract.

 (Rule R-47(d)(ii))

In a AAA Arbitration, if both Parties request attorneys’ fee, the arbitrator may award the fees even if the parties agreed otherwise in the arbitration agreement. This is an important and often overlooked nuance in the AAA Rules as it applies to attorneys’ fees.

JAMS rules are more restrictive than AAA when it comes to attorneys’ fees. The Arbitrator may award if provided by the arbitration agreement or allowed by applicable law. (Rule 24 (g))

Confidentiality is not imposed on the parties by either provider. AAA Rules provide that both the arbitrator and the AAA must maintain the privacy of the hearing unless the law provides otherwise.   (Rule R -25) But that does not extend to the parties. You can ask the Arbitrator for a protective order upon a showing of good cause, but AAA Rules are silent on this issue. AAA’s Statement of Ethical Principles provides that the parties “always have a right to disclose details of the proceeding, unless they have a separate confidentiality agreement.”

JAMS likewise does not impose confidentiality on the parties. JAMS Rules provide that both the arbitrator and JAMS must maintain the confidential nature of the award. (Rule 26 (a)) But that does not extend to the parties. JAMS Rules also provide for the issuance of protective orders. (Rule 26 (b))

 What should your Arbitration Clause look like?

Let’s assume you have decided to commit to an Arbitration provider. What next? Your contract has to match up with what you want to accomplish. The good news in this regard is that AAA and JAMS have done much of the drafting work for you.   Each of these providers provide an excellent online interactive tool to assist you in drafting your arbitration clause. Go to:

 AAA—www.clausebuilder.org

 JAMS—www.jamsadr.com

These drafting tools are excellent at supplying the technical legal language you need. But discuss with your lawyer which parts of these standard provisions you need, and which you do not. For example, issues such as Number of Arbitrators, Arbitrator Qualifications, Locale, Governing Law, Discovery, Duration of Proceedings, Assessment of Attorney Fees and Costs, Confidentiality, Right to Appeal—you may need some of these provisions as part of your standard contract, or you may deliberately want to omit some or all of them. The right answer depends upon the nature of your business, the nature of the job, and the nature of the client, among other things.

Conclusion

No one clause fits all situations. Meet with your lawyer early in the process, do your homework early, and avoid having a clause that is an afterthought on the front end become the most problematic part of your contract on the back end.