Arbitration Clauses in Contracts

Should you include an arbitration clause in your contract?

Arbitration is an out-of-court proceeding in which a neutral third party called an arbitrator hears evidence and then makes a binding decision. Arbitration is the most commonly used method of alternative dispute resolution (ADR), and you'll find an arbitration clause in the fine print of all kinds of contracts these days. Read on to find out whether you should include an arbitration clause in your agreement.

Binding or Nonbinding Arbitration

Arbitration can be binding (which means the participants must follow the arbitrator's decision and courts will enforce it) or nonbinding (meaning either party is free to reject the arbitrator's decision and take the dispute to court, as if the arbitration had never taken place). Binding arbitration is more common.

Who Can Arbitrate Disputes?

Arbitration can be voluntary (the parties agree to do it) or mandatory (required by law). Most contract arbitration occurs because the parties included an arbitration clause requiring them to arbitrate any disputes "arising under or related to" the contract. If a provision like this isn't included in the contract, the parties can still arbitrate if they both agree to it (although it's tough to reach an agreement to arbitrate once a dispute has arisen).

Advantages and Disadvantages of Arbitration

For simple contract disputes in which the matter can be heard in one day, arbitration is usually a good choice. However, if in doubt, consider the advantages and disadvantages, below.

Advantages. Arbitration is usually faster, simpler, more efficient, and more flexible for scheduling than litigation. Also, it avoids some of the hostility of courtroom disputes, perhaps because it's a private proceeding versus the public drama of the courtroom. And if the subject of the dispute is technical--for example, about a patent--the parties can select an arbitrator who has technical knowledge in that field, rather than a judge who may not be familiar with the issues.

Disadvantages. Unlike a court ruling, a binding arbitration ruling can't be appealed. It can be set aside only if a party can prove that the arbitrator was biased or that the arbitrator's decision violated public policy. Unlike a court case, there is no automatic right to discovery (the process by which the parties have to disclose information about their cases to the other party). (However, you can include a requirement for discovery in your arbitration clause or agree to it under arbitration rules.) The costs of arbitration can be significant; in some cases, they may even exceed the costs of litigation (see below).

Still weighing the good and the bad when it comes to arbitration? Learn more in Nolo's article Arbitration Pros and Cons.

What Does Arbitration Cost?

According to a survey by Public Citizen, a consumer watchdog group, the cost of initiating an arbitration is significantly higher than the cost of filing a lawsuit. On average, it costs about $9,000 to initiate a claim to arbitrate a contract claim worth $80,000 (versus about $250 to file that action in state court). Keep in mind that the people in the dispute pay the arbitrators, and arbitration fees can run to $10,000 or more. Add in administrative costs and your own attorney fees (if you hire one) and the process might even cost more than litigation. (For more on the ins and outs of arbitration, check out Nolo's article Arbitration Basics.)

Sample Arbitration Clauses

If you want to include an arbitration clause in your contract, below are some examples to take a look at. Example 1 shows a simple no frills arbitration clause; Example 2 offers more conditions and obligations.

EXAMPLE 1

Arbitration. All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of [insert state in which parties agree to arbitrate] or another location mutually agreeable to the parties. An award of arbitration may be confirmed in a court of competent jurisdiction.

EXAMPLE 2

Arbitration. All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of [insert state in which parties agree to arbitrate] or another location mutually agreeable to the parties. The arbitration shall be conducted on a confidential basis pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Any decision or award as a result of any such arbitration proceeding shall be in writing and shall provide an explanation for all conclusions of law and fact and shall include the assessment of costs, expenses, and reasonable attorneys' fees. Any such arbitration shall be conducted by an arbitrator experienced in [insert industry or legal experience required for arbitrator] and shall include a written record of the arbitration hearing. The parties reserve the right to object to any individual who shall be employed by or affiliated with a competing organization or entity. An award of arbitration may be confirmed in a court of competent jurisdiction.

Do You Need to Hire a Lawyer for Arbitration?

If you have a significant amount of money or property in dispute, you should consider hiring a lawyer to help you in the arbitration. If the arbitrator's decision is binding, you only have one chance to win.

You can use Nolo's Lawyer Directory to find an experienced alternative dispute resolution attorney in your area.

by: Richard Stim, Attorney