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Arbitration provisions, which allow legal disputes to be settled outside of the court system, are increasingly found in contracts of all kinds, including employment contracts. A series of court rulings over the years has spurred the increased use of arbitration clauses. Around one-half of American workers are now subject to mandatory arbitration, although a recently passed federal law makes them unenforceable for disputes involving sexual assault and harassment. Arbitration agreements can also be used in transactions involving customers and vendors.

Generally viewed as proemployer and probusiness, arbitration agreements can help companies avoid expensive, public lawsuits. But arbitration is not always cheap, and it is not necessarily a slam dunk for the company that forces it. To gain the most benefit from arbitration agreements, they should be clearly written and framed in the company’s favor.

What Is Mandatory Arbitration?

Arbitration is a form of alternative dispute resolution (ADR). It is an alternative to filing a lawsuit with the court and going through the judicial process.

Settling a legal dispute through arbitration is not entirely unlike settling a dispute in court, but there are several important differences in a typical arbitration proceeding:

  • Arbitration is overseen by an independent arbitrator rather than a judge. Frequently, the arbitrator is a lawyer, a former or retired judge, a law professor or scholar, or a business professional. However, there are no formal requirements to serve as an arbitrator. The arbitrator can be any individual the parties
  • Arbitration usually takes place in a conference room, and the parties sit around a table. The arbitrator sits at the head of the table and oversees the hearing.
  • Similar to a court proceeding, each side can have lawyers present and call witnesses. The arbitrator swears in the witnesses and listens to their testimony. As in a court proceeding, the other side has the opportunity to cross-examine a witness. The arbitrator may ask the witness questions as well.
  • In addition to witness testimony, an arbitrator reads briefs and documentary evidence. But unlike a judge, the arbitrator may not exclude evidence based on attorney objections. They generally hear all the evidence presented but may weigh the evidence differently.
  • At the conclusion of the hearing, the arbitrator decides who won the case and issues an award. They may give a written statement explaining the outcome. In most cases, the arbitrator’s decision is binding. That is, there is no opportunity for the losing side to appeal.

Where Are Arbitration Clauses Used?

Arbitration clauses were initially used primarily as a more efficient way to resolve interbusiness conflicts, but court decisions since the 1980s have enabled businesses to expand their use of forced arbitration. Arbitration provisions are now commonly used in employment contracts and consumer transactions.

According to the American Bar Association, more than one-half of all workers are now subject to arbitration agreements. Bloomberg reports that the number of employment disputes resolved via arbitration surged by two-thirds between 2018 and 2020. Among companies with one thousand or more employees, 65 percent have arbitration agreements with their workers.

A study published in the UC Davis Law Review found that eighty-one of the one hundred largest companies use arbitration clauses with their customers. An arbitration clause may go into effect when somebody buys a product. Some arbitration agreements are enforceable even without the affirmative act of signing a contract or clicking “I agree” on a website. The clause might be included in the warranty, user manual, product packaging, or a website’s terms of use.

When You Cannot Use Arbitration Agreements

While courts have generally upheld arbitration clauses, President Biden recently signed into law the Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act. The legislation is a response to the #MeToo movement. Some large companies like Facebook, Google, Microsoft, Uber, and Lyft had previously said they would discontinue mandatory arbitration of sexual harassment claims, and now it is the law of the land for all companies.

As you can probably gather from the name of the Act, it makes forced arbitration provisions in employment contracts unenforceable for disputes involving sexual assault and harassment claims. It does not prohibit arbitration in these types of cases, though. Employees can choose to take their case to court or engage in arbitration. Because it is retroactive, the law applies to ongoing cases and invalidates existing arbitration clauses, at least as far as they apply to sexual assault and harassment cases.

What Are the Benefits of Arbitration Agreements?

From a business’s standpoint, mandatory arbitration can provide the following benefits.

Lower Costs

A long, drawn-out employment or consumer lawsuit can result in significant costs for the business that is sued. Arbitration is usually cheaper, at least as far as the actual proceeding is concerned. Arbitration proceedings tend to be more streamlined than court proceedings. Procedural and evidentiary rules that apply in court do not apply in arbitration. Many arbitration schemes also streamline the discovery process, which tends to be broad and time-consuming in court. As a result of these simplified rules and procedures, arbitration is often faster and less expensive than a court case.

Forced arbitration can also save companies a substantial amount of money when the arbitration clause includes a waiver of the right to file a class action lawsuit. Class action lawsuits allow numerous plaintiffs to join together as a single class and collectively bring similar claims against a company. These plaintiffs could be a class of consumers or a class of employees.

In both cases, class actions are preferred by plaintiffs where individual actions are prohibitively expensive, such as an employee class action alleging unpaid overtime or a consumer class action alleging a defective product. Individually, claims may seek damages awards of only a few hundred dollars apiece—hardly worth the cost of hiring a lawyer. But when costs—and awards—can be shared among plaintiffs, they may join together to form a class action. Class action lawsuits have the potential to result in a large settlement or verdict.

Privacy

Most court proceedings are a matter of public record. That means anyone with knowledge of the court system—including journalists—can access your filings and make some details of the case widely known. Private individuals may also be able to attend a trial.

The public nature of court cases can expose potentially embarrassing details about a company, especially if the case involves a sensitive matter like sexual misconduct or discrimination. A company’s reputation is one of its most valuable assets. Reputational damage from judicial action is a very real threat. A company can win the case but ultimately lose in the court of public opinion.

Even if the matter on trial is completely anodyne, many companies understandably want to handle disputes discreetly. Arbitration proceedings and their related documentation are generally kept private. The parties may additionally agree to maintain the confidentiality of the terms of the final resolution.

Are There Any Drawbacks to Arbitration?

Arbitration can be a double-edged sword. Companies that are prepared to live by arbitration should be prepared to die by it as well.

The procedural rules of arbitration could result in an arbitrator making a decision based on information that would not have been admissible in court. If you end up losing in arbitration but think the decision was unfair, you may not be able to appeal the ruling. The Federal Arbitration Act allows for limited judicial review, but the standard for overturning a decision is stringent. And because arbitration is usually private, there may not be records available to back up your claim.

Arbitration tends to be less costly for companies than a court case, but costs can still be high. Potential costs associated with arbitration include filing and hearing fees, administration fees and expenses, rental fees for a hearing room, attorney’s fees, and arbitrator fees. Filing fees for the two leading arbitration providers start at a few hundred to a few thousand dollars.

This might be affordable for a single case, but in response to class action waivers, plaintiffs’ lawyers have started using a strategy called mass arbitration, filing thousands of arbitrations against a company and forcing them to pay hundreds of thousands or millions of dollars in filing fees.

A final point to keep in mind is the public perception of arbitration agreements. As previously noted, arbitration keeps a company’s affairs private and helps with reputational management. But arbitration is seen by some critics as discriminatory and unfair, despite court rulings in favor of arbitration. As a word of caution, be aware of how arbitration agreements are perceived and how they could be weaponized against you in reputational warfare.

The Final Word on Arbitration Agreements

If your company decides to implement arbitration agreements, use their flexibility to your advantage. Select a venue and an arbitrator that are likely to favor you and set arbitration terms that do the same. For example, you may be able to limit discovery to a certain number of interrogatories, document requests, and hours of deposition. Or if you think more discovery would aid your case, you can allow for a lengthier discovery period.

Regardless of the terms you decide on, careful drafting is critical. Before presenting an arbitration agreement to a vendor, an employee, or a customer, consult with an attorney who is knowledgeable about contract law and who can ensure that your agreement is enforceable and that your interests are protected.