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When to Take an Alternative Path
Litigation resolves commercial disputes. However, litigation can be expensive. Litigation can also consume large quantities of the valuable time and energy of a company's employees and owners. Parties to a lawsuit often spend many years pursuing expensive discovery, exchanging documents, taking depositions, fighting over what information should have been produced but was not, proceeding to trial, obtaining a judgment from either the judge or the jury, and appealing the judgment. More often than not, litigation can make even the victorious company ask: "Was it worth it?"
For these reasons, many businesses include arbitration and mediation provisions in commercial contracts. Arbitration and mediation provide the parties with an alternative to litigation as a means of dispute resolution. Companies tout the "speed" of arbitration and mediation and their "inexpensive" nature. While arbitration and mediation certainly offer quick, less expensive resolutions, these advantages are not necessarily the paramount concerns of the parties. Before adopting these provisions as "standard," a company should understand fully the implications of these provisions. Arbitration and mediation have benefits, but such provisions can also have unintended consequences.
Arbitration and Mediation: What is the Difference?
Many commercial contracts contain provisions requiring mediation, arbitration or both. But what is mediation? What is arbitration? Before evaluating whether these provisions should be included in a contract, a party must understand what these provisions mean.
While both mediation and arbitration provide an out-of-court path for solving commercial conflicts, they are very different procedures.
Mediation is formal settlement negotiations. In mediation, a neutral mediator tries to help the parties reach a settlement by hearing and evaluating the positions of the parties. However, the mediator does not have the authority to make a binding decision or award.
Arbitration, however, is informal litigation. In arbitration, a dispute is presented to the arbitrator (an impartial person or persons) who, like a judge or jury, issues a binding determination.
But which one (or both) should be included in a commercial contract?1
Mediation: What Do You Hope to Accomplish?
Since mediation is merely nonbinding, structured negotiations with an expensive referee, a party needs to understand its mediation goals before including a mediation provision in its commercial contracts.
Mediation Provisions Generally
Mediation provisions are not often included in commercial contracts, although they appear to be an emerging trend.
The goal of mediation is to provide a forum for settlement negotiations before a lawsuit is filed or an arbitration is commenced. Parties may include mediation clauses in commercial contracts in an attempt to take advantage of this fundamental purpose. However, a mediation clause may not meet a party's expectations. Mediation is beneficial when all parties participate voluntarily and are prepared to negotiate in good faith to resolve the dispute. Mediation will often fail if less than all parties are of this mindset. Unsuccessful mediation simply results in lost time and money and delays the parties' ability to proceed to litigation or arbitration. Unfortunately, it is often difficult, if not impossible, to determine whether a mediation provision is appropriate for the parties and the future dispute that might arise.
Understanding that a mediation provision may not be desirable in every case, parties may elect to omit a mediation provision from their commercial contract. Even if a contract does not contain a mediation provision, settlement-minded parties can mutually agree to mediate at any time under any terms upon which they agree. It is much easier to evaluate the appropriateness of mediation when the dispute arises and the facts are known. Additionally, a pending lawsuit or arbitration proceeding may serve to increase the pressure to settle.
Understanding the Costs of Mediation
A party needs to appreciate the costs associated with mediation which are in excess of those incurred during informal settlement negotiations. A mediation provision will typically provide that the parties will share the cost of the mediator, who will usually charge an hourly or daily rate which can result in total costs ranging from $1,000 to $10,000 per day. Most mediations can be conducted in a day, but complex cases can take several days. Of course, a party's attorney will almost certainly attend the mediation, so a party can expect to incur attorneys' fees too.
Due to the costs of mediation, a party should consider whether mediation is worth the cost, effort and expense. The more complex and expensive the claims, the more willing the parties are to invest in the mediation and the more likely the parties would benefit from the objective viewpoint of the mediator. However, if the parties have widely divergent positions on the value of the claim and on theories of recovery, a mediator may not be able to bridge the gap.
Evaluating the Likelihood of Success of Mediation
Due to the costs of mediation, a party should also consider the likelihood that a mediation will end successfully (i.e., by fully and finally resolving the dispute). It is disheartening to spend several thousand dollars on a mediation which a party knows to be doomed to fail before it even begins.
By again considering the complexity and value of the potential claims, the parties may be able to determine whether mediation is likely to succeed or fail. If a claim is relatively straightforward and if the distance to "middle ground" is not too great, a mediator might be the ideal vehicle for arriving at a compromise.
Additionally, if the parties have an existing relationship, they will know each other's negotiating style and may understand their attitudes toward conflict resolution. Evaluating these factors will help a party determine the likelihood that the other party will be open to good faith settlement discussions.
A clause providing that the parties "may" mediate a dispute is simply a permissive clause and could very well result in mediation not occurring.
If the parties decide to include a mandatory mediation provision in their contract, they will need to decide whether the provision will be absolute, meaning that all disputes which cannot be settled by negotiation must be mediated before other dispute resolution procedures can be utilized, or whether the provision will include certain parameters (i.e., only claims of a certain dollar amount will be mediated, claims for injunctive or other equitable relief will be excluded, etc.).
If the parties elect to include a mediation provision in their contract, they should also consider including a mechanism which prevents one party from delaying the ultimate resolution of the dispute by failing to participate in the mediation. In the event that one party fails to participate in a mediation during a specified time period, the provision should permit the non-delaying party either to compel mediation or, at its option, proceed directly to the next level -- arbitration or the courts.
Where Should the Mediation Take Place?
The parties will need to agree on the location of the mediation, especially when the parties are located in different states.
What Are the Qualifications of the Mediator?
If the parties would benefit from a mediator with industry expertise, they should specify the qualifications of the mediator.
Who Will Bear the Costs?
Shared mediation costs tend to impose a certain willingness on the part of each party to engage in good faith negotiations. Lack of financial investment in the process can translate into lack of emotional investment in the negotiations.
Arbitration: Do You Understand the Pros and Cons?
Once negotiations -- formal or informal -- have been exhausted without success, the parties will need to decide the forum in which they will prosecute their claims: a courtroom or a conference room. Before committing to arbitration, however, a party should understand the unique aspects of arbitration and the benefits and problems such a choice entails.
The Unique Aspects of Arbitration
Speed of Resolution
Arbitrations permit speedy resolutions of disputes. While lawsuits can easily proceed from complaint to trial over the course of several years, arbitrations typically can be concluded within six months.
Typically, plaintiffs prefer to proceed to judgment quickly so that they can collect what they claim is owed to them. Defendants tend to act in a more deliberate fashion, gathering all evidence necessary to defend against the plaintiff's claims. Accordingly, if you are the party more likely to have a grievance against the other party, you may want to include an arbitration provision. The party more likely to have a claim filed against it may prefer to resort to the court system.
The discovery period of a lawsuit -- when the parties serve and respond to interrogatories, produce relevant, non-privileged documents to each other, and conduct depositions -- can be incredibly time-consuming and costly. While there are some limits on discovery in a lawsuit, the process is generally very lengthy and its focus is extremely broad.
In an arbitration, however, discovery is generally not part of the ordinary progress of a case. While an arbitrator generally will approve a request of a party to conduct written discovery, the permitted discovery will likely be limited in scope and expedited. Depositions are the exception rather than the rule.
The limited discovery in an arbitration can be both a shield and a sword, depending on the circumstances of the case. An objective way of measuring the impact of limited discovery is by considering the dollar amount and the complexity of the possible dispute. The higher the value of and the more complex the claims, the more likely a party would prefer the formal discovery procedures available through the courts. For a less complex, less expensive case, however, arbitration's limited discovery provides an ideal cost-cutting tool.
To address the concerns of limited discovery in an arbitration, the contract can include a trigger for arbitration based on the dollar amount in dispute. For instance, a clause could provide that the parties will arbitrate any dispute where the amount in controversy is less than a certain dollar amount. When the amount in controversy exceeds that amount, the parties will resort to resolution through the courts. Parties utilizing such a provision should also agree that all claims must be brought simultaneously so that a party cannot avoid the dollar limitations by bringing claims piecemeal.
Additionally, parties can adopt a contract provision permitting certain specified discovery, thereby avoiding a discovery ruling by the arbitrator which is too limited.
Appeal Only in Limited Circumstances
The right to appeal is a valuable one. Claims of a high dollar amount can impact the financial stability of a party. Complex claims could be decided incorrectly. If a party receives an unfavorable verdict from a judge or jury, the party has a broad right of appeal. It is very difficult, however, to appeal an award from an arbitrator.
In cases governed by the Federal Arbitration Act, an arbitrator's award cannot be overturned except in the following, rare circumstances:
- where the award was procured by corruption, fraud, or undue means;
- where there was evident partiality or corruption in the arbitrators, or either of them;
- where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or
- where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final and definite award upon the subject matter submitted was not made.
9 U.S.C. § 10(a) (emphasis added).
Additionally, a federal court may overturn an award that is (1) arbitrary and capricious; (2) in contravention of public policy; or (3) entered in "manifest disregard of the law." Scott v. Prudential Securities, Inc., 141 F.3d 1007, 1017 (11th Cir. 1998), cert. denied, 525 U.S. 1068 (1999). To manifestly disregard the law, one must be conscious of the law and deliberately ignore it. Montes v. Shearson Lehman Bros., Inc., 128 F.3d 1456, 1459 (11th Cir. 1997). Accordingly, to arbitrate, a party must be prepared to submit to strict controls on the appellate process.
If the parties choose to arbitrate, to preserve the limited right to appeal, a party should have a court reporter transcribe the arbitration hearing. Without a record, an appeal is virtually impossible. Number of Arbitrators
The parties are responsible for the arbitrator's hourly or daily rate. Generally, an arbitration provision will either specify one arbitrator or make no mention of the number of arbitrators. If no number is specified, it is likely that only one arbitrator will be selected. Some arbitration provisions, however, specify three arbitrators.
Obviously, the more arbitrators, the higher the arbitration costs. Because multiple arbitrators serve as checks and balances of each other, a party might be willing to bear the increased cost of three arbitrators when the claims are very expensive and/or highly complex.
Qualifications of Arbitrator(s)
The parties should consider whether their industry or the nature of their dispute requires an arbitrator with special qualifications (i.e., construction, real estate, technology). If so, the arbitration provision should specify the necessary expertise required. Further, as arbitration is similar to litigation, the parties may want to require the arbitrator to be an attorney with a certain number of years of practice in a certain area of law.
The Filing Fee
While the overall cost of an arbitration tends to be less expensive than that of litigation, the initial fees in arbitration can be much higher than court fees. The most substantial costs of an arbitration are certainly the fees of the arbitrator and the partys' attorneys. However, the filing fee for the arbitration is another material cost.
When a party files a complaint with a court, there is a minimal filing fee, typically less than $200. However, most arbitration services charge a filing fee based on the dollar amount of the claim. For example, the American Arbitration Association charges a $750.00 filing fee for claims above $10,000 and up to $75,000. For claims over $1,000,000 but under $7,000,000, the filing fee is $6,000.00. The sliding-scale fee structure is another reason to consider a dollar limit on claims subject to mandatory arbitration.
There are a large number of organizations which offer arbitration services, both nationally and internationally. The parties should specify in the contract the arbitration service which will conduct the arbitration and which rules, offered by the arbitration service and tailored to the nature of the dispute, that they wish to use.
While arbitration rules provide a basic structure, they do not offer all of the protections available in litigation. For example, under the typical rules of an arbitration service, evidence rules do not apply. Accordingly, the hearing could involve a witness testifying about a letter which the witness neither sent nor received. To avoid hearsay and other troublesome issues, the parties may want the contract to provide that the Federal Rules of Evidence or a certain state's evidence laws will apply. Before including such a provision, however, a party should determine whether all necessary witnesses are either willing to participate in the arbitration hearing or can be compelled to do so. If not, the party may decide it needs to take advantage of the less formal arbitration rules.
The Substance of the Arbitrator's Award
The arbitrator's award will usually include a basic statement as to which party prevailed on what claims and the amount of the award. However, the arbitrator's award may not specify the bases for the award. To preserve potential grounds for appeal and establish the rights of parties which may have an ongoing relationship, the contract can require that the arbitrator include detailed findings of fact and conclusions of law in his or her award.
Avoid Self-Inflicted Statute of Limitations
Setting deadlines for initiating an arbitration can have unintended consequences. If parties are not careful, they may inadvertently create statutes of limitation much shorter than applicable law provides. For example, a provision which requires a party to initiate an arbitration within 30 days after written notice that negotiations (or a mediation) have failed could result in the party's claims being barred in either litigation or arbitration if the party does not initiate the arbitration within 30 days. A better method is simply to provide for arbitration of disputes without setting a deadline.
Exclusivity of Arbitration Provision
The arbitration provision should exclusively provide for arbitration (except in cases involving equitable relief). Unless it specifies that all disputes arising out of or related to the contract shall be arbitrated, either party will be able to "opt out" of the arbitration provision by filing a lawsuit before an arbitration has been initiated.
Escape Valves for Equitable Claims
As an arbitrator may not be able to implement and enforce appropriate and sufficient injunctive or other equitable relief, the parties should draft the contract to permit a party to apply to a court for such remedies.
Location of Arbitration
The parties should agree in advance as to the city and state where the arbitration will be conducted, thereby avoiding any conflict over this issue at a time when the parties are no longer interested in accommodating each other.
What Law Will Govern?
The parties should agree in advance as to which state's law will control the dispute.
Who Bears the Costs of Arbitration?
An arbitration provision should also specify how the expenses of arbitration should be apportioned: (i) will they be shared equally during the arbitration? (ii) can the arbitrator award the prevailing party reimbursement for its share of the arbitration costs?
One of the ways to avoid the "American rule" -- that each party bears its own attorneys' fees -- is to contract around it. The parties to a contract containing an arbitration provision should decide whether the arbitrator will be permitted to award the prevailing party its reasonable attorneys' fees.
Understanding Dispute Resolution Methods
Disputes will continue to arise in the course of commercial transactions. These controversies will be resolved through one or more dispute resolution methods: negotiations mediation, arbitration or litigation. By understanding the positive and negative aspects of these options before committing to one, a contracting party can ensure that it is accomplishing all of its goals while avoiding many pitfalls.
While this article highlights some of the main issues surrounding arbitration ans mediation, it is not intended to be comprehensive. To ensure that contract provisions are comprehensive and meet all expectations, a party should consult an attorney. ↩