Not Always the Right Move

IT'S NOT UNUSUAL for a waste company owner to want to avoid going to court to settle every dispute with a customer. “That's why I have an arbitration clause in my standard service agreement and why I look for comparable wording in contracts with vendors, suppliers and others,” the owner might say.

It seems logical that someone who runs a business would want to speed up the resolution of past due accounts and other disputes, while keeping a lid on costs. But arbitration is probably not the sure-fire answer.

During the past 25 years, arbitration clauses have grown in popularity throughout the business community as a way to avoid the time and expense typically associated with litigation. However, no studies or surveys exist that substantiate the faster-and-cheaper assumption. In fact, anecdotal evidence indicates otherwise.

For starters, the arbitration process can generate litigation even before an arbitrator enters the picture. Parties can sometimes find themselves in court arguing about whether the arbitration clause itself is enforceable and, if so, whether it covers all issues. When large awards are made, parties often file a judicial challenge at the end of the process. In between, participants in arbitration quickly discover that the process can be slow and expensive.

Crowded dockets can motivate judges to move cases through the court on an expedited basis. By contrast, arbitrators who are paid by the hour may not feel pressure to limit the length of the proceeding or to narrow the issues. The following cases, although not representative, demonstrate that arbitration is not always a shorter and less expensive alternative to litigation.

Several years ago, an arbitration proceeding between a company and a former employee consumed 50 days of hearings over a period of two-and-half years. Follow-up trial court proceedings and appeals lasted another three years without a final resolution. An appeals court ended up setting aside a $25 million punitive damages award, but sent the matter back to the arbitration panel for further testimony and evidence. [Sawtelle v. Waddell & Reed Inc., 304 A.D.2d 103 (N.Y.App.Div. 2003)]

In another arbitration proceeding, 59 witnesses appeared and testified, and transcripts of the proceeding ran to more than 24,000 pages. Post-hearing motions by attorneys for both sides created an additional 700 pages. For good measure, the plaintiff's attorney was awarded a fee of nearly $750,000. [Engel v. REFCO Inc., 746 N.Y.S.2d 826 (2002)]

Arbitration under federal law, which covers most arbitrations, offers no right to the pre-hearing discovery that is available in litigation. Moreover, an arbitrator has no obligation to honor a request by a party for a subpoena for witnesses or documents. Supporters of arbitration cite these features as proof that arbitration is the quicker and cheaper solution.

Yet, without thorough discovery, each side loses the opportunity to anticipate the other side's case and avoid surprises. Instead, both parties could end up spending lots of time and money preparing for any and every eventuality, and have no incentive or basis to settle the matter at an early stage based on the relative strengths of each side's position.

For the most part, parties may not appeal an arbitration decision. Under federal law, a court may vacate an award only if the award resulted from fraud or undue means, or if the arbitrator was biased, unreasonable or otherwise acted so as to prejudice the rights of a party. Another ground for judicial review is “manifest disregard” for the law, which does not include a mere mistake. It comes into play only when the law is absolutely clear, is applicable to the facts of the case, is understood by the arbitrator and is intentionally disregarded.

As for review of the size of an award, an error by the arbitrator would have to be at the outer boundaries of outrageous and capricious before a court would intervene. In short, whatever satisfaction a business may get from knowing it has avoided a courtroom could easily be outweighed by an unjustifiable arbitration award with no place to complain.

For good measure, a party can be subjected to punitive damages as part of an arbitration award. An arbitrator can award punitive damages unless the parties have drafted a clause that expressly prohibits such damages. But even a plainly stated ban is no guarantee. Some courts have invalidated such a restriction as against the public policy of the state and thus allowed the awarding of punitive damages. [See, for example, Thicklin v. Fantasy Mobile Homes, Inc., 824 So.2d 723 (Ala. 2002)]

Is an arbitration clause in a contract a mistake? Yes, if the parties think they are getting an automatic discount on time and charges for resolving disputes that might arise, or if they think the result inevitably will be better than what can be achieved in court.