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The Key to Arbitration Clause Provisions is Careful Handling

Businesses often insert an arbitration clause in a contract based on the expectations that arbitration is cheaper and faster than a lawsuit. Unfortunately, a poorly drafted arbitration clause can lead to a messy legal dispute that is neither cheaper nor faster. Transaction-oriented lawyers have their strengths, and litigation is generally not one of them. As a result, they may not anticipate all of the ramifications of the provisions they insert in an arbitration clause. Sometimes an attorney borrows from a well-crafted contract that is ill-suited to the needs of the current client. In a sincere but misguided effort to cover all bases, an attorney may insert language that is overly expansive, overly restrictive or just plain impractical. This is particularly true in maritime matters.

In my years as a claims executive ultimately paying for arbitration proceedings, a lawyer appearing before arbitrators and advising clients on contracts that other lawyers have drafted, I have learned to analyze arbitration clauses in the same way that a coach may watch videotapes of games. Because there are various nuances to drafting arbitration clauses, it is good to highlight the most important questions when reviewing a proposed contract.

Set Goals
  • What do you want to accomplish? One reason for arbitration is to achieve a private resolution out of the eye of the public and competitors. The other main reasons are to avoid costly trials and drawn-out disputes.
  • What will be arbitrated and what will not? When asked, courts generally rule broadly regarding what is covered by arbitration. All issues in a construction contract should be--but tort claims, probably not.
  • Are provisions for arbitration consistent and harmonious with other provisions of the contract? If not, resolving conflicts and confusion within the document may protract and complicate the proceedings.
  • Is the arbitration nonbinding? If the answer is yes, then clearly, somebody was not thinking when writing the contract. If an arbitration ruling cannot be enforced, the two sides will still end up in court after going through a time-consuming and potentially expensive set of hearings or reluctantly unsatisfactorily reach a result that is less then satisfactory.
Choose Players
  • How many arbitrators? Base the number on the size of the contract. If it is a simple dispute, one arbitrator will do. If the agreement has complex issues and involves considerable money, you may want a panel of three. Remember that costs rise with the number of arbitrators.
  • Who chooses the arbitrators? Independent groups such as the American Arbitration Association, the Judicial Arbitration & Mediation Services and the Society of Maritime Arbitrators offer qualified individuals.
  • Who pays the arbitrators? The cost could be split between the two sides or paid by the loser in the dispute.
  • What are the roles of the arbitrators? A contract may say that each side picks one arbitrator and those two pick the third who manages the arbitration. If the clause fails to state that the first two arbitrators should act in a neutral fashion, they may be advocates and engage in a tug-of-war over the third to gain a 2-to-1 victory. This is less than ideal.
  • Can there be independent communication with the arbitrators? Yes, when the advocate arbitrators are not neutral. The two sides argue the case before the arbitration panel and separately talk to their arbitrator--not a good situation.
Keep Score
  • Will attorneys fees be awarded for the prevailing party? Not unless there is a provision for it in the contract.
  • What type of award may be made? Both sides should know ahead of time what they might gain or lose and why. There are multiple types of awards: standard (amount and breakdown), reasoned (arbitrator gives reasons) and findings of fact and conclusions of law (arbitrator makes findings). The more complicated and detailed the award, the more expensive. The type of award should be specified in the contract.
  • Does the winner take all? Use the legal standard of preponderance of the evidence in weighing how much to award to each side.
  • What rules apply? In the contract, pick rules of arbitration, either AAA, SMA or some other rules designated specifically for arbitration.
In summary, while company owners and managers expect attorneys to know how to draft every page of a contract--reality can fall short of expectations. A business should choose an attorney that is experienced in arbitration and contract drafting in the particular area of law to undertake this very important task. Undertaking this step by step analysis before signing on the dotted line is the difference between signing a contract and crossing fingers that all will ultimately come out ok and signing a contract, knowing that the language chosen is well suited for the business and risks that comes with that business.

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