In modern American jurisprudence, the use of arbitration to resolve commercial disputes is now common. While arbitration has many advantages for closely-held businesses and their owners, it also has multiple drawbacks. In this blog post, we will highlight that dichotomy so that owners of closely-held businesses can make an educated decision whether to integrate arbitration provisions into their commercial agreements and what to expect should they find themselves in an arbitration proceeding.

Arbitration is a type of dispute resolution in which the parties have agreed to litigate that dispute in a private forum rather than in a public courtroom. Thus, instead of a judge and jury hearing the parties’ evidence and making a decision on the merits of a case, the parties have hired a private third-party “neutral” or “neutrals” to hear the evidence and to make a decision based upon evidence that the parties and their counsel present. The parties may include a provision to arbitrate any hypothetical dispute as part of their initial contract or they may agree to arbitrate a dispute after it has arisen.

Both Georgia and Federal law have statutes that recognize the legitimacy of arbitration as a means for parties to resolve their disputes. In fact, court systems throughout the United States strongly favor the resolution of civil disputes through arbitration for one simple reason – it clears cases from their overcrowded dockets. Thus, public policy encourages parties to arbitrate commercial disputes.

The Big Corporation’s Use of Arbitration

Large corporations often use arbitration provisions as part of their standard form agreements. They include these provisions because it provides them control over what could be potential far-flung litigation. For example, a large corporation that has suppliers throughout the United States does not want to litigate around the country should a dispute arise between its suppliers and itself. Thus, in its supplier contracts, the large contractor often includes a provision that states something like the following:

The parties agree to resolve all differences or disputes arising out of or relating to this Agreement shall be resolved and settled by final and binding arbitration administered by the Judicial, Arbitration, Mediation Services (J.A.M.S.) pursuant to J.A.M.S.’s then-current arbitration rules. Any such arbitration shall be conducted before a single arbitrator in a proceeding held in the Atlanta, Georgia area. The arbitrator shall have the authority to award attorneys’ fees, arbitrator’s fees, J.A.M.S.’ fees and other costs to the prevailing party.

The lesson for the closely-held business owner – be careful what you sign! Make sure you understand that your company’s rights can be adversely affected if you enter an agreement that traps you in an arbitration proceeding far from home.

The Upsides of Arbitration

For the closely-held company, there are three major upsides to using arbitration as an alternative to litigation.

The first advantage is that generally arbitration takes less time from start to finish than does litigation. With litigation, there is a pleading stage, a costly discovery process, a motion process, a trial, and, potentially, an appeal. When combined with a typically overcrowded docket, it can takes years for a dispute to be resolved in today’s court systems. By comparison, the typical arbitration proceeding significantly shortens the discovery process, usually eliminates the motion process, utilizes a hearing before one person instead of a full-blown jury trial, and, except in extraordinary circumstances, eliminates the ability to appeal the arbitrator’s decision.

The second upside to arbitration is the ability to have a dispute heard by an expert in a field related to your industry. For example, a practitioner with experience in the construction industry typically will decide a dispute between a contractor and a subcontractor. Thus, the disputants should have confidence that the person deciding their dispute will understand the terminology and practices used within the industry.

The third advantage to the arbitration process is its finality. That’s because there is virtually no ability to appeal an arbitrator’s decision unless the losing party can somehow show that the arbitrator acted fraudulently or with gross negligence. Consequently, once the process is over, it’s over. Of course, the finality of that process cuts both ways, as the loser of the arbitration hearing has virtually no chance of winning an appeal, no matter how unjust he thinks the result.

The Downsides of Arbitration

For the closely-held company, while there are upsides to using arbitration as an alternative to litigation, several significant downsides also exist.

The first and foremost is cost. Arbitration is expensive because it is private. Unlike typical litigation where the taxpayer largely pays for the judge, the judge’s clerks, the courtroom, the clerk’s office and the court of appeals, during arbitration, the parties pay. They pay for the arbitrator or arbitrators, usually at an hourly rate comparable to that of an attorney. They also pay the company that organizes the arbitration proceeding. That company can be the American Arbitration Association or similar entity, which charges fees based both on the amount of money in controversy and the amount of time needed to administer the process. In other words, the costs associated with private litigation can mount quickly.

Another significant downside to arbitration is that the losing party has extremely limited opportunity to appeal an adverse ruling, even if the facts and the law might otherwise support such an appeal. Public-policy strongly supports the arbitration process as a relief valve for the overcrowded court dockets. Thus, the courts have generally decided that once the parties have decided to take their dispute out of the system, it should stay private and out of the system.

Finally, a downside that can occur in arbitration relates to a power or economic disparity between arbitrating parties. If one party has significantly more assets than the other, arbitration can be an extremely taxing process for the less wealthy party. Costs add up quickly between fees to the arbitration entity, fees to the arbitrator(s), attorney fees, discovery expenses, etc. Thus, it is important for the closely-held business owner to understand what comes with arbitration. It is not an area for the unwary.

At my firm, we specialize in helping closely-held businesses navigate through the mine-fields such as the one described here. If you have questions about arbitration or any other legal issue related to your business, don’t hesitate to e-mail me at fgoldman@fggpc.com. Just put – “A Closely-Held Question” in the subject line. You can also follow me on Twitter.