To Arbitrate or Not to Arbitrate? That is the Question

A dispute resolution clause in your contracts is like a seat belt: It’s a critical safeguard that can easily be taken for granted during smooth rides. While most days you won’t think about it, the day you need it you’ll be very glad you have a good one.

Given their importance, you might expect that dispute resolution clauses are generally carefully negotiated and drafted. Unfortunately, that’s not always the case. Many are, quite frankly, a bit of a mess, especially when they incorporate an arbitration provision. It turns out that both lawyers and their clients don’t always fully grasp what arbitration involves or how it functions, despite regularly submitting to its framework.

So, in this article we are going to take a closer look at arbitration, with an eye towards helping you assess when it might be useful in your next transaction or when you might want to avoid it. We’ll also outline a handful of best practices when it comes to the content of an arbitration provision.

Let’s take it from the top.

What is arbitration?

Dispute resolution aims to end a dispute. Certainly, other goals may be part of the equation, like maintaining or fostering relationships, vindicating rights, deterring wrongdoing, compensating victims, and so forth. But the second word in the phrase “dispute resolution” makes clear that putting an end to the fight matters.

Still, there are a lot of ways to end a fight. Dispute resolution, then, exists along a spectrum. At the lease formal end sits party-to-party negotiation. Here, parties settle their own problems. On the other, more formal end, sits a trial in a public court. Here, a judge makes a final decision (subject to the appeals process). On that spectrum, arbitration is much closer to public court adjudication. Like a public court process, arbitration provides a final and binding outcome, regardless of whether the parties are happy with that outcome or not.

What distinguishes arbitration?

Arbitration derives its power from a deliberate choice and a firm commitment. The choice entails opting out of the public court system, and instead committing to the final and binding judgment of a private arbitrator, handpicked by the disputing parties themselves. In other words arbitration is an alternative to, and in a sense a competitor with, public courts.

In short, arbitration is a voluntarily chosen process where the parties commit the final and binding resolution of their dispute to the judgment of a third-party neutral, the arbitrator.

What are the Pros and Cons of Arbitration?

Sometimes there’s no right answer, but there are often wrong ones. With respect to the choice about whether to arbitrate or litigate in public court, this adage can come in handy. Frequently, the best decision hinges on there being a clear reason not to go to court or a clear reason not to arbitrate.

Keeping that in mind, there are several potential benefits to arbitration, including:

It’s often faster and maybe (but not necessarily) cheaper. Time is money, and arbitration can move fast. That can be a real draw to the process. Legal traffic jams caused by bloated dockets and burdensome processes, including layers of appeals, can slow courts down. Arbitration avoids all that by scooting cases into the fast lane and potentially shaving months or even years off the waiting time for a resolution. That said, as discussed below, arbitration may actually end up more expensive than courts, especially in larger and more complicated cases.

The parties can choose expert adjudicators. One of the hallmarks of arbitration is that parties choose their decision maker. Remember that judges are busy generalists. While they may have a lot of experience in business disputes generally, they usually lack the sort of industry-specific expertise that could be really useful. Arbitration allows you to select an arbitrator who knows what’s what in the motor industry and is, therefore, right for your particular fight.

The parties can keep the dispute private. Courts are public. Arbitration is not. This means that parties who opt to go to arbitration can keep their fight out of the public eye. This can often be useful when parties have a legitimate fight but don’t want to ruin their entire relationship over it.

Arbitration keeps things simple. In arbitration, parties in conflict can focus the dispute resolution process on their actual needs rather than on abstracted and impersonal ideals of justice or, more cynically, on procedural jockeying that serves only to rachet up costs. Arbitration processes tend to be simple, and the parties or arbitrator can modify or alter those processes in the interests of efficiency and justice.

Arbitration awards are enforceable internationally. Internationally, arbitration constitutes the key mechanism for adjudicating disputes for one big reason: the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention) makes it a relatively simple matter to enforce arbitral awards almost anywhere in the world. In contrast, it is quite difficult, if not outright impossible, to enforce a court judgment outside of the country where it was rendered. So, if you have a dispute with a manufacturer in China and you get a judgment in a UK court against that manufacturer, you will run into serious challenges enforcing that judgment in China. On the other hand, if you get an arbitral award against the manufacturer, you’ll have very little difficulty getting the award enforced in China. In short, if you’re doing business internationally, arbitration is your best option for dispute resolution.

That all makes arbitration sound quite appealing, and often it is. But there can also be downsides.

There is almost no right of appeal. Arbitrators generally have the last word in a dispute. There are extremely limited rights to appeal an arbitral award, and almost all the rights that do exist focus only on the process and not the merits. In other words, unlike a judge in a court, if an arbitrator makes a mistake about the facts or the law, their decision usually still stands. So, a tremendous amount hinges on whether you have a good or a bad arbitrator.

The upfront costs are higher. Arbitrators get paid directly by the parties, whereas judges are paid by the taxpayer. This means that the upfront costs of arbitration can be much higher than in court, depending on how much arbitrators charge. Some of the upfront costs are made up by the comparative speed of the process, but that’s certainly not always true. Arbitration can be expensive.

Arbitrators may have incentives to split the difference in their awards. Arbitrators may have incentives to avoid rendering too decisive a victory to any party. A losing party may then hold a grudge against an arbitrator. That losing party might then refuse to appoint the arbitrator in another case or might sully the arbitrator’s reputation. To avoid these possibilities, arbitrators are sometimes inclined towards a compromise, “split the difference” award.

The relative informality may be a drawback. Procedural hurdles can be frustrating, but they can also level the playing field, making sure that both sides have a fair chance in the fight. Arbitration puts a lot of power into the hands of the arbitrator, which is fine if you have a good arbitrator but can turn ugly if you have a bad one.

In short, no dispute resolution process is perfect. Arbitration is an alternative to courts, and that alternative can work well in some cases. In others, it may be better to stick to the court process.

If you choose to arbitrate, what should be in your arbitration provision?

Arbitration can pay big dividends, but a poorly drafted arbitration provision undermines many of the benefits of the process, creating collateral fights about process that have nothing to do with the merits of a dispute.

There are several key ingredients to a good arbitration provision, including:

A clear scope. Parties may choose to arbitrate whatever disputes they want. In complex contracts, it might be beneficial to segment disputes, with some going to arbitration and others going to court. Generally, though, such segmentation is not good idea. It’s usually better to keep it simple and say that “any and all disputes arising out of or related to this contract are arbitrable.”

The “seat” of the arbitration. This is a term of art. The “seat” of the arbitration is the place where the arbitration is legally located. In other words, this is the jurisdiction whose arbitration laws will apply to the arbitration process. Many arbitration agreements omit this provision, at the peril of the parties.

The hearing location. The location for the hearing does not have to be the same as the seat. The location for the hearing is literally the space (virtual or physical) where the arbitrator and parties will meet to decide the dispute.

The number of arbitrators and their minimum qualifications. Most arbitrations have one or three arbitrators. One makes the process cheaper. Three gives the process more safeguards at a higher price. In any event, the arbitration provision should also consider if there are any minimum qualifications that the parties would like the arbitrators to have.

Identification of the applicable arbitral institution, if any, and rules. Most arbitrations take place with the help of an arbitration institution, like the London Court of International Arbitration (“LCIA”). The institutions provide essentially administrative support, and they usually supply a roster of potential arbitrators that they have vetted and approved. (Remember how important it is to have a good arbitrator, so these lists can be quite beneficial.) The institutions also provide a prefabricated set of rules to govern the process. Parties may forgo the institution and go it alone, but if they do so, they will still want to select in their agreement an applicable set of arbitration rules, like the UNCITRAL Model Rules.

If the dispute resolution provision is tiered, clear boundaries for progression to the next step. It’s very common for a dispute resolution provision to include tiers: first, the parties will attempt to negotiate in good faith; second, if that doesn’t work out, the parties will mediate; and finally, if all else fails, the parties will go to final and binding arbitration. The progression is clear and sensible enough, but what’s missing is a timetable for moving to the next step. Any tiered clause should include a simple and understandable basis for the progression. So, for instance, after a formal notice of a dispute, the parties might agree to attempt informal negotiation for 30 days. If that doesn’t work, then they will appoint a mediator and attempt to mediate within 45 days. If that all fails, then, and only then, may either party submit their dispute to arbitration.

Any arbitration provision should have, at a minimum, these ingredients. If you’re looking at a contract that includes an arbitration clause and it doesn’t have at least these elements, then you’re looking at a problem waiting to happen.

Conclusion

Taking the time to think through your dispute resolution clauses is an investment in safety and assurance that can make all the difference when you least expect, but most need, it. A well-crafted dispute resolution clause can absorb the shock of business disruptions caused by contractual disagreements, keeping costs contained, streamlining resolution of the fight, and improving your chances of an overall favourable outcome. Arbitration is one possible mechanism that, in appropriate cases, can be a valuable means of streamlining procedures and giving you access to expert adjudicators and easily enforceable awards. But arbitration isn’t right in every situation.

As always, we’re here to help you think through your specific needs and weigh the various dispute resolution options.