Notes & Comment
Vol. 2009, No. 2
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Business Law
Random Thoughts on Arbitration
The mission of organizations such as the American Arbitration Association and the Judicial Arbitration and Mediation Service is the development and widespread use of prompt, effective and economical methods of alternative dispute resolution (ADR), including arbitration. An arbitration proceeding is not a judicial proceeding. McDonald v. City of West Branch, Michigan, 466 U.S. 284, 288 (1984). "Arbitration is a private dispute resolution mechanism instituted pursuant to an agreement between the parties. It occurs predominantly outside, and in lieu of, court proceedings. [T]he arbitration [is] governed by a private agreement to arbitrate disputes… Indeed, by choosing arbitration, the parties have decided not to submit their legal controversy to the state courts." Six Clinics Holding Corporation, II v. Cafcomp Systems, Inc., 119 F.3d 393, 398 (6th Cir. 1997).
According to one recent study, an overwhelming number of corporate respondents favor continued use of arbitration to resolve international (cross border) legal disputes and are satisfied with the process. On the other hand, many are skeptical that arbitration is an effective ADR option. Some have even asked if arbitration is "lawless" (meaning a process that's without legal substance and lacks procedural structure).
To Arbitrate or Not to Arbitrate?
In concept, the promise of arbitration is an ADR mechanism that's less formal than court, allows legal disputes to be resolved faster than a civil lawsuit and is cheaper than conventional litigation. But do people who arbitrate disputes get what they bargain for?
As noted, arbitration is a creature of contract. The parties agree in a written contract to submit future disputes to arbitration. Contracts which contain arbitration clauses rarely go into nitty-gritty detail about how a prospective arbitration should work, so the operational details are often left to rules established by the arbitration organization designated by the parties, usually in their contract.
Courts generally give great deference to written arbitration agreements and grant wide latitude to the decisions of arbitrators. But arbitration, being a private dispute mechanism, presupposes that the parties police themselves to meet its promise of faster, cheaper and less formal. When that doesn't happen -- when the parties don't restrain themselves, discovery gets out of hand, disruptive motions are filed, deadlines are missed -- the arbitrator must be prepared to mete out meaningful consequences. Otherwise, there's no reason to have confidence in the "informal-faster-cheaper" arbitration paradigm.
Recent experience with one commercial arbitration proceeding, while purely anecdotal, offers several observations about the efficacy of arbitration as an ADR option:
1. Appointment of the Arbitrator. An arbitration forum's rules usually include clear procedures for selecting an arbitrator from a panel of possible neutrals. If the parties can't agree on an arbitrator, each party is allowed to confidentially rank and submit its top 3-5 choices (out of a panel of 10 candidates) based on each panelist's experience and cost (billable rates). Relevant experience is important because the arbitrator's learning curve in, say, a complex construction dispute, ideally would be small. Cost is important because the parties generally split the arbitrator's fees. But there's no transparency in the outcome of arbitrator selection. In other words, a neutral not on a party's ranked list might be chosen by the case administrator without explanation, rendering that party's preferences about experience and cost meaningless. There's very good reason, when the parties can't agree, to require "neutral" selection of the neutral, so as not to permit one party to impose its choice of arbitrator on the other. But why ask the parties to participate in the selection process at all -- why request cost and experience preferences? -- if the case administrator ultimately chooses someone else, the decision-making is opaque and the final selection is never explained?
2. Discovery and Motion Practice. Once an arbitrator is appointed and a case schedule is established, self-restraint by the parties is critical to limit and expedite discovery, achieve milestones, and minimize motion practice in the run-up to the hearing. Otherwise, what's the point of arbitration? Why sacrifice the procedural protections of state or federal court, including the threat of sanctions by a supervisory judge, by submitting to an arbitration process that tolerates corner-cutting, discovery delay and abuse, and aggressive pre-hearing motion practice -- all presided over by a potentially passive arbitrator unwilling to mete out consequences? Dilatory (and costly) litigation tactics can sometimes be successfully employed in an arbitration that "deep pocket" counsel would never get away with in a court proceeding. Finally, each time a party asks the arbitrator to get involved, that party's cost to arbitrate increases because it's usually paying half the arbitrator's fee.
3. Keeping on Schedule. This is perhaps the arbitrator's most important task, but it's easy to quickly get off schedule with pre-hearing delays, discovery disputes and motion practice. It's intuitive that a system which depends on the parties policing themselves also depends on an arbitrator willing to "crack heads" to keep the parties on schedule. Further, once they've agreed to a duration for the hearing the parties should be required to streamline their respective evidentiary presentations during the hearing itself. Federal judges often assign a not-to-exceed specific number of hours for each side's civil trial presentation. Lackadaisical management of the parties' discovery practices and case presentations at the arbitration hearing are perhaps useful to insure that everyone "has their say" but does little to promote the "informal-faster-cheaper" arbitration option. The ADR process particularly breaks down when the hearing must be adjourned mid-stream and resumed later because pre-agreed allotted times for presenting the case are exceeded.
4. The Award. A recurring general criticism of arbitration is the compromise nature of arbitral awards. Despite adequate discovery, pre-hearing briefing and a thorough development of the evidentiary record, the arbitration award can run the risk of being a "split the baby" proposition. Who can say if "being on the payroll" of both parties tends to promote compromise awards? Compounding this perception is the relatively limited judicial review of arbitration decision-making. Again, as noted, courts grant wide deference to arbitrators consistent with the need to promote arbitration as an effective ADR option. Courts are loath to second-guess arbitrators' management of those proceedings except in cases of obvious misconduct. One party can prevail on all legal issues and still be subjected to a "compromise" solution fashioned by the arbitrator from thin air which is not susceptible to meaningful judicial review.
Summary and Conclusion
A single commercial arbitration experience does not establish a norm nor is it sufficient to reflect negatively on the efficacy of arbitration as an ADR option in general. Alternatives for federal and state court litigation are of course desirable and necessary -- the more the better -- if for no reason other than to offer choices in the face of declining judicial budgets and overburdened court systems. No ADR process will be perfect. But the informal-faster-cheaper promise of arbitration is, in many cases, illusory and disillusioning.
As one who writes many different types of commercial and intellectual property agreements, adding an arbitration provision has almost always been the rule, not the exception. Unfortunately, that's no longer the case. And if our draft agreements do include an arbitration clause, provisions are added which try to anticipate and prevent some of the more vexing structural problems with arbitration noted above.
© Matthew Joseph 2009. Law Offices of Matthew Joseph, San Mateo, California, practices in the areas of intellectual property licensing, commercial real estate leasing, corporate formations and business transactions. No legal advice is intended by the information provided herein and recipients should independently consult counsel before taking any action related to this subject matter.