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Smart Start with Contracts: When to Include an Arbitration Clause in Your Contract

Owning a business involves a certain amount of risk. A dispute with a customer or contractor may require you to seek legal counsel. But protecting yourself and your business can start with how your contracts are written. Knowing when and why to use an arbitration clause in a contract can help you make savvy contracting choices, regardless of your industry.

An arbitration clause is an addition to a contract requiring parties to resolve disputes through mediation that takes place outside the courtroom. Surveys show that while approximately 75 percent of all consumer agreements contain arbitration clauses, only about 25 percent of all types of contracts do. And overall, studies show that arbitration clauses reduce the number of claims filed against companies who include them in their agreements, as well as the overall value of settlements when claims are filed.


Pros and cons of arbitration clauses

Advantages of arbitration include the freedom to hand pick at least some of the individuals who will resolve potential disputes. In addition, the procedures for arbitration can be customized, which reduces the cost of resolving a dispute. Costs are also reduced because arbitrators typically award smaller, more reasonable verdicts than juries. Arbitrators also generally hear and decide cases more quickly than the courts.

Arbitration can also have disadvantages. Because arbitrators are less likely than courts to dismiss cases, many claims that would not have made their way into a court will be accepted by arbitrators. And while informal proceedings cost less, arbitrators can allow a larger amount of evidence to help them decide a case. Another disadvantage is that there is no automatic right to appeal or deny the award of an arbitrator in the event of a flawed decision. Perhaps most significantly, arbitrators have a tendency to “split the baby,” or to find fault on the part of both parties.


When to include arbitration clauses

When should a business include an arbitration clause in its contract? While this question cannot be answered with absolute certainty, there are certain situations for which arbitration clauses are more properly suited.

  • Routine cases: When cases involve smaller amounts of money, arbitration can help speed things along and limit expenses. Examples include contracts for the sale of goods and construction contracts.
  • Joint ventures and franchise agreements: Arbitration can help preserve ongoing relationships like franchise agreements, because the informality of the process puts parties less at odds with one another.
  • Disputes with consumers/employees: A combination of the previous two examples, arbitration is often the preferred venue for disputes with consumers and employees.
  • Trade secret / embarrassing cases: If you have something you want to keep out of the public eye, arbitration is probably the way to go.


When to avoid arbitration clauses

Alternatively, arbitration clauses probably should not be included in agreements in the following situations:

  • Clear cut legal issues and defined contract terms: Procedural dismissals are more likely to be effective in these circumstances. In this situation, arbitration may be more expensive than litigation, since it is more likely to continue until the arbitrators issue a decision.
  • Bet-the-company disputes: When the well-being of the company depends on a single agreement or series of agreements, litigation is generally the better option. The uncertainty of arbitration, and the likelihood that the arbitrators will find fault with both parties, makes arbitration risky.
  • Desire for appeal / emergency relief: Arbitration is not the best option if emergency relief such as a temporary restraining order is necessary. Unlike a sitting state or federal court judge, arbitrators must be selected or appointed. The selection process can often take weeks. Also, if the issue is complex or undefined to the extent that it could be appealed, arbitration is probably not the best option.
  • Potential benefit of lengthy proceedings: Under certain circumstances, the length and cost of traditional litigation may be beneficial. While your company may be able to afford costly and lengthy discovery, motions practice and proceedings, your opponent may not. This situation may assist you in obtaining settlement more easily.

Understanding when and why to employ arbitration clauses in your businesses’ agreements will help your company to succeed where others may fail.

  • Partner

    Since joining the firm in 2009, Alex has concentrated his practice in the area of complex commercial litigation in federal and state trial and appellate courts. Among his experience, Alex has litigated disputes involving class ...

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