Choosing Arbitration?

With early signs of an economic recovery, developers, investors, and lenders have cautiously started exploring the possibility of new deals. With new deals come new contracts, and with new contracts come questions about some of the "standard" provisions to which many of us have grown accustomed. Over the past ten years or so, mandatory arbitration provisions have become standard in many real estate and lending contracts. However, the disputes that have arisen over the past three years have shown that arbitration may not always be the quickest or least expensive solution.

To begin, it is important to understand some of the characteristics of arbitration that could make it an attractive option: (1) in an arbitration the parties have the ability to agree on an arbitrator of their own choosing, rather than having a judge assigned to their case at random; (2) arbitration files remain confidential, while court records are generally open to the public unless specifically filed under seal; (3) in an arbitration, the parties can choose the discovery and procedural rules ahead of time instead of being bound by the rules of civil procedure (though blindly choosing standard arbitration rules could result in a process at least as expensive as a court proceeding without the tried and true benefits of standard discovery practices); and finally (4) a binding arbitration provision might allow a large institutional party dealing with many customers to avoid class action law suits.

That said, arbitration comes with a cost. In an arbitration, the parties are responsible for paying the hourly rate of the arbitrator. Meanwhile, in the court system, parties only have to pay the standard filing fees – they do not have to pay for the judge's time (at least not directly). Additionally, some arbitration firms charge heavy administrative fees, which could run as high as $10,000 for a $1,000,000 claim, and certain default arbitration rules might even require the use of three arbitrators for high-dollar disputes (regardless of the complexity), which effectively triples the cost of the proceedings. Finally, arbitrators do not have the same powers as a judge, and cases involving foreclosures or evictions are best handled through the court system.

Therefore, prior to including an arbitration provision it is important to consider both the characteristics of arbitration as well as the nature of the parties' deal. This will allow the parties to make an informed decision about whether arbitration is the best option for them. If it is, then it becomes vital to craft the arbitration provision carefully so that the ground rules for the arbitration are in place before a dispute arises.

Otten Johnson's attorneys have substantial experience in helping clients plan ahead for disputes that could arise from their business deals. For more information on this Client Alert or for help evaluating your current situation, contact any of the attorneys in the Litigation practice group (for a listing, click here).

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