An arbitration clause is a clause in a contract that requires the two parties to resolve disputes via a neutral third party called an arbitrator.

Arbitration Clauses in Contracts

Arbitration involves an out-of-court proceeding during which an arbitrator listens to evidence and announces a binding decision. This is commonly used for alternative dispute resolution, which results in an arbitration clause in contracts.

If two parties opt to resolve their dispute using arbitration, they can use it to negotiate:

As long as both parties agree to it, they can use arbitration after a dispute arises.

Binding and Nonbinding Arbitration

There are two common types of arbitration:

  • Binding. This is the more common option. It means the parties must adhere to the arbitrator's decision, as enforced by the court.
  • Nonbinding. Either party can deny the arbitrator's decision and take the issue to court. It's as if the arbitration never occurred.

In addition, arbitration can be voluntary (both parties agree to go this route) or mandatory (the law requires the parties to do it). Most contract arbitration happens because the parties had an arbitration clause that requires them to go to arbitration if any contract-related issues arise. If the contract doesn't have this clause, the parties can still choose arbitration if they both agree to it.

Advantages and Disadvantages of Arbitration

There are several advantages and disadvantages when it comes to arbitration. Advantages include the following:

  • Saves time. Arbitration is typically a faster and simpler option for finding a resolution.
  • Offers flexibility. Parties interested in arbitration have more flexibility in scheduling when compared to litigation.
  • Privacy. Arbitration occurs outside the courtroom, so you avoid the hostility and public drama found in courtroom disputes.
  • Selection. If the dispute involves technical aspects, the parties can choose an arbitrator who has that type of knowledge over a judge who might not be familiar with those issues.

Some disadvantages of arbitration include:

  • Cannot appeal. While you can appeal a court ruling, you cannot appeal a binding arbitration ruling. You can reject it only if you can prove the arbitrator was one-sided or the decision goes against public policy.
  • No right to discovery. Court cases use automatic right to discovery, which means each party must reveal information about their case to the other party. However, you can add a requirement for discovery in the arbitration clause.
  • High cost. Arbitration can be expensive — often more expensive than litigation.

What Does Arbitration Cost?

The consumer watchdog group Public Citizen conducted a survey and found that the costs of entering into arbitration are much higher than the costs of filing a lawsuit. On average, it takes approximately $9,000 to initiate an arbitration claim on a contract worth about $80,000. It costs about $250 to take the case to court.

In addition to the filing cost for an arbitration, you must pay arbitration fees that can run up to $10,000 or more. There are also administration costs and attorney fees, if you decide to hire one, and the entire bill can run more than that of litigation.

FAQ

When you consider drafting an arbitration clause, you should ask several questions, including:

  • Should I arbitrate or litigate? If your dispute is vital, you might opt for a full legal process, including appeal. If your dispute is more suitable for an expert familiar with the legal and technical aspects than a jury, you might choose an arbitration. In addition, an arbitration tends to result in a quicker decision. So if your dispute is a timely issue, select an arbitration.
  • Do I need an administered arbitration? Allowing a third-party administration to become involved will add to the cost of the arbitration. However, it is often the best option. These administrators have extensive information about qualified arbitrators that specialize in the area of your dispute. If you don't use administered arbitration, you must specify the rules that apply to the issue.
  • Should I select a single arbitrator or an entire panel? While panels tend to provide more knowledge about the issues, they can cost about three times more than a single arbitrator. Consider the size and importance of disputes when deciding on this option.

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