The Pitfalls of Arbitration

Before you agree on Arbitration, think twice.

By David J. DelCollo, Esq.

It is a common practice in contracts to include an arbitration clause, upon which parties are usually happy to agree.  Arbitration is the submission of a dispute to an unbiased third person designated by the parties to the controversy, who agree in advance to comply with the award of which the decision is to be issued after a hearing at which both parties have an opportunity to be heard.  Unlike litigation, arbitration takes place out of court with much less procedure than that of the court system.

Arbitration has a long-standing history in the United States.  The first real implementation of arbitration took place in 1920 with the passage of the first state arbitration law in New York.  In 1925, Congress enacted the Federal Arbitration Act of 1925 (FAA) which really made the idea of arbitration both an acceptable and ideal way to do business.

Today, most contracts contain arbitration clauses.  In many situations such as gaining employment, obtaining a loan, and even signing up for internet services, a party does not even have the ability to choose the option of arbitration, but rather, they are forced into it by the larger, more powerful entity.  While arbitration clauses are described as being the speedy, efficient, inexpensive, and fair alternative to jumping through the cumbersome hoops of the American legal system, is this the truth behind arbitration?   Is arbitration really a better alternative to litigation or rather a venue for big business to flex its muscles?

Well, with regard to arbitration being inexpensive, arbitration is not free.  Arbitrators usually charge high fees for their services.  In addition, the arbitration may contain provisions about fees and fee splitting that end up costing much more than a lawsuit in the end.  There are usually up-front fees charged by the arbitration services that must be paid by both parties which can sometimes be very difficult for the aggrieved party.  When a party agrees to arbitration, they agree to waive their rights to a jury trial, and this typically puts the party with bargaining power at a significant advantage, whereas the weaker party has given up a valuable right to a just outcome.

Another problem with arbitration as a whole is that arbitration awards create no precedent.  The corpus juris of our common law system is built on the court’s interpretation of the law and the application of the law to specific cases.  Arbitration does not seek to either advance or evolve the common law system. Ultimately, this failed nexus between arbitration and common law creates something even more damaging, and this is that an arbitrator is not bound by any precedent or substantive law, making the arbitration process completely unpredictable.  Many of the laws that protect consumers and employees become meaningless and unenforceable in arbitration.

One of the greatest concerns with regard to arbitration is that of finality.   It is extremely difficult to get a court to vacate an arbitration award, for if arbitration awards were susceptible to judicial review, the very system of arbitration would erode.  Generally, the courts will only vacate an arbitration award if it was obtained through sometime of undue means, such as fraud or corruption.  In assessing undue means, the courts will seek to vacate an award if it can be shown that the arbitrators demonstrated a “manifest disregard of the law.”  The courts have found that this “disregard” can be found when the arbitrator’s conduct of the proceeding prejudiced the rights of a party or where the arbitrators exceeded their power under the arbitration agreement.

In our civil court system, if either party feels that the outcome of a case was reached in an unfair or unjust manner, that party is free to seek appeal of the case, at which point the case is heard by another court who can affirm or appeal the decision.  This system of appeals ensures that one has the opportunity to achieve the closest result resembling that of justice.  In arbitration, however, the outcome is final and binding on the parties, with no opportunity to appeal the decision in order to ensure that the arbitrator made the right decision or that the parties were treated fairly.

This leads us to the issue: if one has entered into a contract with an arbitration clause, is one bound by that arbitration clause, or is there a way around it?  The answer to this question lies in the concept of “unconscionability.”  The concept of unconscionability has been traditionally described by the courts as being conduct that is unusually harsh and “shocking to the conscience” in so much as to allow such conduct would be grossly unfair and unjust to one of the parties involved.  The concept of unconscionability was found solely in complex legal theory and law school textbooks up until about a quarter century ago when the courts began to attack these arbitration clauses by utilizing the theory of unconscionability.  If a court finds that an arbitration clause is unconscionable, they may (1) refuse to enforce the entire contract, (2) enforce the remainder of the contract, but invalidate the unfair terms, or (3) limit the action of unfair terms to avoid an unconscionable result.  While this type of court resolution offers some refuge for those parties that find themselves in a precarious situation due to such an arbitration clause, keep in mind that you could have a long and expensive fight on your hands in the civil courts, only to get you back into the civil courts to litigate the issue at hand.

Whether you are a business or an individual, you should very carefully consider if you are comfortable with arbitration before you sign the agreement.  Most companies have arbitration clauses in contracts because they want to maintain their slanted playing field, should anything ever go awry.  And while at a glance, arbitration seems like a way in which the parties can avoid the pitfalls of litigation, the outcome often is much worse, allowing little recourse for the parties involved.