The Pluses and Pitfalls of Arbitration

In a previous article, titled “Crafting a Strong Sales Contract,” I discussed the importance and huge potential cost savings to a business of having a well-written contract with its customers.

One provision that has become more commonplace is arbitration. It is a type of out-of-court, alternative dispute resolution mechanism in which a civil (noncriminal) dispute may be heard and decided expeditiously, cost effectively and privately by an arbitrator, instead of by a judge or jury. After taking testimony, reviewing evidence and hearing arguments similar to a trial but without the same formal rules of procedure and evidence, the arbitrator issues a binding “award,” which can be registered and enforced in court just like a judgment after a trial.

While arbitration has become a popular form of dispute resolution, it may not be right for all businesses at all times. While arb “might” be faster, cheaper and confidential, it could hamper the business in defending or bringing an action.

In Ware v. C.D. Peacock Inc., in a decision handed down by a federal trial judge in Chicago, a major retailer required its employees to sign an employment agreement containing an arbitration provision. The provision required that any disputes arising out of an employee’s employment with the employer be arbitrated instead of litigated in court.

Employee Ware sued the employer in federal court, claiming discrimination based on age, race, and color when she was demoted. Attempting to put the case out of court, the employer raised the arbitration clause in the employment agreement. In response, the employee acquiesced to arbitration.

Before arbitration (where discovery is limited), counsel for the employer sought permission from the arbitrator to take the deposition of a non-party, who was a key witness for the employee. The arbitrator granted permission, but the non-party moved to quash the subpoena in federal court, arguing that the Federal Arbitration Act prohibited depositions of non-parties before the actual arbitration hearing. The federal judge agreed, meaning that counsel for the employer could not depose this key witness before the arbitration, leaving counsel guessing as to what this witness would testify to at arbitration. So, while the employer insisted on arbitration in its agreement—ostensibly to keep the dispute private from the press and other would-be employee-plaintiffs—it was faced with going to a hearing against its employee on serious discrimination charges without knowing all the facts. Few litigators and surely no business enjoy trial by ambush.

While many businesses prefer arbitration because it can be less expensive, quicker, and private (not a matter of public record, as a lawsuit is), great care should be taken in deciding whether arbitration is actually preferable to court, or should all disputes be subject to arbitration or “carved out” of the arbitration provision, and what the content of the arbitration provision should be.

When a service business client, after consultation, has decided that arbitration is appropriate in its agreement with its customers, we at times have crafted an arbitration provision, as follows:

ARBITRATION. Any claim or controversy relating to this Agreement and the conduct, activities and services of the Company, except a claim by Company against Client for the payment of any fee, shall be resolved informally by the parties or by binding arbitration conducted in accordance with the rules of the American Arbitration Association (the “AAA”), before one arbitrator. The arbitrator shall be selected from a panel of arbitrators knowledgeable about the ______________ industry. The parties agree that the laws of the State of Illinois will govern the interpretation of this Agreement. The parties also acknowledge that venue for any arbitration or litigation relating to this Agreement and the conduct, activities and services of the Company, will be within Chicago, Illinois. The arbitrator shall hear motions to strike, motions to dismiss and/or for summary judgment, and enforce full discovery rights in accordance with the provisions of Illinois Supreme Court Rules, the Illinois Code of Civil Procedure and Circuit Court of Cook County Local Rules. The parties may commence discovery upon the selection of the arbitrator. Discovery shall be permitted for a period of not less than 120 days and shall be concluded not less than 60 days prior to the final hearing. Within 30 days of the hearing, the arbitrator must give a written award setting forth the material facts and legal basis for his or her award. The arbitration award shall be final. Judgment upon the award may be confirmed by any court having proper jurisdiction. IF CLIENT FAILS TO INITIATE A DEMAND FOR ARBITRATION WITH THE AAA WITHIN ONE YEAR OF THE DATE OF THE AGREEMENT, CLIENT SHALL BE FOREVER BARRED FROM INITIATING ARBITRATION PROCEEDINGS AGAINST THE COMPANY. In such an event, it shall be considered conclusive evidence that Client is satisfied with the Company's performance relating to the Agreement and the conduct, activities and services of the Company, and Client agrees to release the Company from any and all liability relating to the Agreement, and the conduct, activities and services of the Company.

Note that the foregoing arbitration clause provides for discovery such that the business will not be trying the case “blind,” as happened with the employer in the Ware case. However, because full-blown discovery is provided for in the above sample provision, that right is reciprocal and the client (or employee, as the case may be) may also conduct discovery on the business. And discovery can be costly, which offsets one of the benefits of the streamlined arbitration process. However, on balance, and after exploring the many factors that determine whether arbitration or court is better for the business, this business, with assistance of counsel, opted for arbitration and the terms of this provision.

Accordingly, before a business decides to provide for arbitration in its contracts with its employees or customers, counsel should be consulted. And in deciding whether arbitration is preferable to court, counsel should brainstorm with the business about prior, pending and potential future disputes, covering all eventualities and other factors bearing on the content of the arbitration clause.

While arbitration may be the new hot thing, it may not be for all businesses or for all types of disputes. A business can control its destiny with a sound contract, including a solid, well-drafted arbitration provision.

Steven N. Malitz is a partner in the Litigation Practice Group of Arnstein & Lehr LLP and is the firm’s pro bono chair. He can be reached at 312.876.7134 or snmalitz@arnstein.com.


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