Mandatory Arbitration Clauses, Beyond Just Boilerplate

Mandatory Arbitration Clauses, Beyond Just Boilerplate, by Rebecca Gray for Contract NerdsMandatory arbitration provisions fall within the “big hairy problem” category of boilerplate contract clauses. Not because they are particularly complex; though they can be. But because the calculus involved in deciding whether and when to require arbitration of contract disputes is more nuanced than most give it credit for.

It may be tempting to gloss over mandatory arbitration clauses with the knee-jerk assumption that alternative dispute resolution is a net positive.  But there are many situations in which mandatory arbitration – one type of alternative dispute resolution – is not the best path forward.

As one commentator put it, “the only real advantage to having an arbitration clause in a contract is the ability to force the other side to arbitration even if they don’t want to go.” Before you spend precious time and legal resources on that perfect arbitration clause, though, you’ll want to think long and hard about the potential downsides of finding yourself on the pointy end of your own drafting.

Litigation vs. Arbitration

Sometimes, you will be better off heading straight to the courthouse, regardless of what the contract says.

For example, if you need to compel someone to do – or stop doing – anything, court is going to be the better option. Arbitrators simply do not have the same powers of compulsion that judges do. Similarly, if there is a real possibility the other side will fail to appear, you’ll probably want to file in court, where you can obtain a default judgment. Arbitration rules often don’t allow default judgments. Instead, arbitration rules usually require “the party who is present” to spend time and money proving their case even if no one else bothers to show (e.g. AAA R-31).

Streamlined procedures and limited (or nonexistent) discovery can make arbitration significantly faster and cheaper than litigation. But this is only true where the parties collaborate to take advantage of the increased flexibility of arbitral procedures to limit costs and achieve a timely resolution. Where one party has greater resources and benefits more from maintaining the status quo, that same flexibility can be used as a weapon to increase costs and stall resolution.

An Arbitration Clause Can Increase Uncertainty.

One of our most important jobs as Contract Nerds is to reduce or eliminate uncertainty stemming from the contracts we prepare.

Arbitration is often touted as a path to increased certainty because you generally can’t appeal arbitral decisions. In the U.S., when you agree to arbitrate, you have bargained for the arbitrator’s interpretation of your contract, and you are stuck with it “however good, bad, or ugly.”

But there is a big difference between agreeing to alternative dispute resolution procedures for a particular dispute after it arises, versus drafting a contract to require arbitration of any present or future claim, “whether directly or indirectly relating to” said contract. Even where both parties consciously agree to include a mandatory arbitration clause in a contract, there is a significant risk that the aggrieved party will ignore the clause and file in court anyway. This can drive up legal costs before you even get to the heart of the dispute, because you’ll spend time and money fighting over where, how, and by whom your claim should be decided.

An arbitral award may be more final and therefore more certain than an appealable court judgment. But the very flexibility of arbitration procedures, coupled with limited powers to compel cooperation, makes arbitration vulnerable to delay and abuse, i.e., inherently less certain. Costs will spiral quickly if you get bogged down in court fighting over threshold issues, like whether your arbitration clause is enforceable, the scope of the tribunal’s power, who will sit on it, or even where the arbitration will take place.

How the Ubers of the World Leverage Arbitration

Mandatory arbitration clauses tend to benefit big business defendants in the business-to-consumer or large-scale employer context.

Statistics show that consumers and employees are at a disadvantage in arbitration – they win less frequently and receive smaller awards when they do win. There is also a measurable advantage to “frequent flyers” in the arbitration setting, in part because an arbitrator’s inclinations and past decisions generally can’t be divined from any public record. And let’s not forget that mandatory arbitration clauses have served an important role in overall strategies for limiting class actions.

This is why Uber, Lyft, Amazon, and Grubhub have fought hard in recent years to enforce their arbitration clauses. For an excellent, (if biased) overview of the legal backdrop for these cases, check out The Arbitration Epidemic by the Economic Policy Institute. It notes that the courts’ willingness to enforce mandatory arbitration clauses in the 80’s, 90’s, and early aughts “enabled large corporations to force customers and employees into arbitration to adjudicate practically all types of alleged violations…[effectively giving] corporations a ‘get out of jail free’ card for all potential transgressions.”

The pendulum is shifting away from certainty even in the business-to-consumer or large-scale employer context, though, as indicated by the recent spate of decisions refusing to enforce arbitration clauses in the First, Third, and Ninth Circuits. As a result of the Third Circuit’s decision, Uber wound up back in federal district court, in the midst of discovery on the preliminary question of whether or not its arbitration clause is enforceable.

Clearly, the Ubers of the world think it’s worthwhile to spend a great deal of time and money trying to enforce mandatory arbitration clauses. But for the rest of us, unless we have a specific, compelling reason to prefer arbitration of all claims plausibly related to a particular contract, we’re probably better off skipping that mandatory arbitration clause, and instead waiting for a dispute to crystallize before we decide how best to resolve it.

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Check out my previous article about boilerplate contracts and stay tuned for the next installment about indemnification clauses.

© 2021 The Entrepreneur’s Lawyer®

Author:
Rebecca serves as outsourced in-house counsel to businesses and entrepreneurs, working to develop legal strategies that create opportunities for growth while protecting and increasing value. She founded The Entrepreneur’s Lawyer® to create a home for the resources and guides she wished she had readily available as a newly minted #startupGC.

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