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Are Mandatory Arbitration Clauses Bad Policy and Bad for Business? A Look At The Pros and Cons

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  • Posted on: Jan 2 2018

Should Your Business Contracts Contain Mandatory Arbitration Clauses?

Mandatory arbitration clauses have increased in popularity in recent years and are now part of most business contracts. While arbitration clauses are not ideal for all situations, this method of dispute resolution can provide benefits to both businesses and customers alike. 

What is an Arbitration Clause?

Arbitration is an alternative form of dispute resolution where the parties voluntarily agree that a neutral, private person will resolve any legal disputes between them, instead of a judge or jury in a court of law.

A mandatory arbitration clause is a contractual provision in which one party requires the other to arbitrate their disputes.  Such clauses are often found in a contract’s “terms of agreement,” including those used for employment, insurance, home-building, car loans and leases, credit cards, retirement accounts, investment accounts, and nursing facilities, among others. While the exact terms and conditions differ depending upon each business, most mandatory arbitration clauses limit the rights of a party to appeal an arbitral award and prevent claimants from pursuing their claims as a class action. Further, some mandatory arbitration clauses impose a cap on damages and require a non-disclosure agreement to be signed.

Arbitration Clauses – The Upside and Downside

There are advantages and disadvantages associated with the arbitration of disputes.  Below are some of the advantages:

  • Since the parties agree to resolve their disputes by arbitration, the parties are indicating their confidence that the arbitrator, the rules governing the proceeding, and the forum in which the arbitration will take place are, and will be, impartial and fair.
  • A dispute in arbitration typically gets resolved sooner than a litigation in court.
  • Arbitration is usually less expensive than litigation in a court.
  • Unlike a trial, arbitration is a private procedure.  Thus, if the parties want privacy, then the dispute and the resolution can be kept confidential.
  • There are limited opportunities for either side to appeal an arbitral award. This gives finality to the resolution of the dispute that is not often present with a judgment after trial.

There are, however, some disadvantages to arbitration, which are discussed in the next section.

Incomplete Justice?

A “one-size-fits-all” policy, mandating arbitration for all disputes, unnecessarily shoehorns disputes that would otherwise be more appropriate for the court system. Critics of mandatory arbitration clauses point to the incomplete justice that is sometimes administered in the name of efficiency and finality.  A few of the criticisms are discussed below.

First, the agreement to arbitrate is not negotiated. Mandatory arbitration allows one party (typically the business or employer) to force the other party (usually the customer or employee) to use arbitration for dispute resolution. In most instances, the consumer or employee is unaware they have agreed to arbitrate their disputes and are, therefore, unaware of the rights they have given up.

Second, if arbitration is binding, both sides give up their right to an appeal. That means there is no opportunity to correct an erroneous decision.

Third, if the matter is complex, but the amount in controversy is modest, then the fees and expenses imposed by the arbitrator and the arbitral forum may make arbitration uneconomical.

Finally, the rules of evidence may prevent some evidence from being considered by a judge or a jury, but may nevertheless be considered by an arbitrator. Thus, an arbitrator’s decision may be based on evidence that a judge or jury would not consider at trial.

Limitation of Rights?

In addition to losing the right to appeal any unfair judgments, mandatory arbitration clauses also limit other rights. Typically, the complaining party has a more limited access to evidence and witnesses. 

Moreover, mandatory arbitration clauses can limit the public’s ability to expose corporate misbehavior — that is, the deterrent effect that litigation can impose on other companies engaging in the same or similar misconduct. 

Limiting Class Action Lawsuits?

Mandatory arbitration clauses often include a provision that prohibits claimants from litigating their claims as a class action. In a class action, the claimant brings an action on behalf of a group of similarly situated people with damages that were caused by the alleged wrongdoer.  Class action lawsuits provide legal redress for people who, on their own, would likely not bring because their claim is too small to litigate on their own. Class action waiver clauses are used by businesses and employers to reduce the risk of collective or class action litigation.  

Takeaway

 The use of mandatory arbitration clauses in business and consumer contracts has grown in recent years. In most cases, consumers are not aware of mandatory arbitration clauses, because they are located in the fine print within a user agreement.  Many critics of mandatory arbitration consider such clauses to be unfair.

Despite the perceived unfairness of requiring a party to arbitrate a dispute as a condition of the transaction or employment, recent Supreme Court cases have upheld the right of companies to insert mandatory arbitration clauses in their agreements with other companies or consumers.

Perhaps unsurprisingly, mandatory arbitration clauses have become the latest weapon in the political arena. Responding to the Obama administration’s ban on the use of mandatory arbitration clauses in financial contracts, the Trump administration has now reversed the ban. With the legally-imposed cap on mandatory arbitration clauses lifted, this popular form of alternative dispute resolution is likely to grow.

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