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Heading to Arbitration? What to Know Before You Sign the Dotted Line

I n-house counsel are often confronted with contracts that force them to anticipate whether litigation or arbitration will be used for dispute resolution. Unfortunately, these executives rarely have the appropriate information to make that decision. Moreover, if a company is inclined to agree to a mandatory arbitration clause, there is typically little or no conversation about what the language in the actual clause should be.

Instead, if a party makes the decision to agree to mandatory arbitration, that is the usually the end of the analysis. A stock arbitration clause like the one found in form contract documents is adopted with little or no consideration for the impact of that clause, or of options for modification that ought to be considered.

In this article, we plan to (1) provide information to allow in-house counsel to make informed decisions regarding whether to choose arbitration over litigation, and (2) if arbitration is the preferred method of resolution, present some issues to consider when drafting an arbitration clause.

Arbitration versus litigation considerations

There are a number of important considerations when deciding between arbitration or litigation. Generally speaking, arbitration is perceived to be less expensive and formal than litigation, and a faster way to end the dispute. To that end, the American Arbitration Association (AAA) has recently re-emphasized the importance of speed and efficiency to its roster of arbitrators. Note also that issues concerning speed and efficiency can be controlled by a company executive by carefully drafting an arbitration clause, as discussed below.

Another critical distinction is the difference in the level of education and expertise in a judge and jury versus an arbitrator or an arbitration panel. Industry issues are often complex and highly technical and many juries (and judges) aren't as knowledgeable as arbitrators.

Bright judges struggle with many of the concepts because they are, due to the nature of the job, generalists and usually have had limited exposure to the legal and factual issues that arise in industry-specific disputes. To counter this, groups like the AAA maintain a roster of arbitration neutrals, specific to industry segments, with a high level of experience and expertise with the legal and factual issues found in a specific industry.

[Related: Tailor Your International Arbitration Agreements] (PDF)

The flip-side to speed and efficiency of arbitration is the potential lack of procedural safeguards. One reason arbitration can be more efficient is because those safeguards — rules of evidence, procedure, and appeal rights — are limited or (for all practical purposes) eliminated when compared to litigation.

For example, the procedural safeguards regarding the admissibility of evidence are more of a guide in arbitration, whereas in litigation they are strictly enforced. Perhaps the biggest procedural safeguard lacking in arbitration is appeal rights. Generally speaking, once an arbitration award is issued, it is very hard to appeal. However, a right to appeal can be included in an arbitration clause. But again, this general principle is one of the reasons arbitrations can be more cost effective.

Another "litigation versus arbitration" consideration is privacy. An arbitration is a private event and, more likely than not, will remain private. Conversely, litigation is rarely — if ever — private, so a party must be prepared to have its "dirty laundry" aired if it chooses litigation.

The considerations discussed above are not exclusive, but are salient considerations when weighing the decision to litigate or arbitrate. Of course, if the choice is arbitration, then a company executive's job is not complete. The next step is careful consideration of the language of the actual arbitration clause.

Arbitration clause considerations

If arbitration is the chosen path, there are still many aspects to consider before signing a contract with a mandatory arbitration clause. For example, in architecture (the authors' industry), it is easy to find an standard arbitration clause language in the form library of the American Institute of Architects (AIA). In-house counsel should not assume that the "one size fits all" approach represented by a standard form clause works for their company.

This is not meant as a criticism of the standard form language, but an acknowledgment that a standard form clause may not address every issue that an in-house counsel may believe is important. Instead, carefully consider all aspects of the potential arbitration.

One tool available to the public to help with this process is provided by the AAA, which has a "Clause Builder" tool at its website. The Clause Builder tool has a set of comprehensive questions to the reader and, based on the answers, suggests points and possible contract language to consider when completing a contractual arbitration clause.

When an in-house counsel considers an arbitration clause, the first step is to determine what the scope of the clause will be. What sort of disputes do you want an arbitrator to have authority to decide? What is the scope of an arbitrator's authority in deciding a dispute?

[Related: Ten Steps to Keep Your Clients Out of Court] (PDF)

A part of this is thinking about what remedies an arbitrator should be able to impose. Another consideration is whether the arbitration process will be administered by a commercial service, like the AAA, and if so, will its standard Commercial Rules of Procedure be adopted, or something more specific like the Construction Industry Rules?

Arbitrator selection is also an important component of any arbitration process. Parties can pre-select an arbitrator or, if using a commercial arbitration service like AAA, use one of the methods of selection. The AAA maintains a roster of arbitration neutrals qualified to hear disputes, and as part of the arbitration administration process, will walk the parties through arbitrator selection.

In addition, an important part of this process is the management of arbitrator conflicts and disclosures, to ensure that the arbitrator is in fact impartial and neutral. To the extent a commercial service like the AAA does not maintain a roster of neutrals for a specific industry, a party can insert into an arbitration clause the criteria for education and experience that an arbitrator must have in order to serve as a neutral on a dispute.

Next, you should consider the location of the arbitration and what state law will apply. At this point, you should also consider the practical and procedural aspects of an arbitration process. Will the parties be allowed to conduct discovery, and if so, to what extent? Will witnesses be called live in an arbitration hearing, or will the hearing be decided only on documents and briefs submitted by the parties?

[Related: Developments in Litigation Technology: Early Sleuthing and Scoping]

Another important consideration is what sort of award is requested. Typically, arbitration awards come in two forms, which are a standard award and a reasoned award. A standard award generally does not address how an arbitrator made a decision and instead simply states what the decision is, in terms of liability finding and any resulting remedy or damage award.

A reasoned award generally addresses the arbitrator's decision-making process, discussing the findings of fact and law which drove the decision, as well as detailing the liability, remedy, and damage findings that result from the process. To the extent appeal is an option in arbitration, a reasoned award is recommended because a standard award provides very little for the party charged with conducting the appeal to review to consider.

The stakes involved in business disputes can be enormous and the issues complex. Careful consideration should be given to the issues raised in this article, and a company should not overlook these important decisions in exchange for a "one size fits all" approach to dispute resolution.

About the Authors

Beth RayBeth Ballew Ray serves as Managing Counsel for Balfour Beatty Construction in Austin, TX.

Ben WheatleyBen Wheatley is the managing shareholder of Munsch Hardt’s Austin office and currently serves on the firm's operations committee. Ben has more than 25 years of experience in litigating complex construction and environmental matters, negotiating and drafting construction and design contracts, master service agreements, serving as in-house counsel for an international design firm and working on issues concerning the practice of architecture, engineering, and project construction.

The information in any resource collected in this virtual library should not be construed as legal advice or legal opinion on specific facts and should not be considered representative of the views of its authors, its sponsors, and/or ACC. These resources are not intended as a definitive statement on the subject addressed. Rather, they are intended to serve as a tool providing practical advice and references for the busy in-house practitioner and other readers.