ADR - Law Firms Institution Versus Individual: The Arbitration Alternative To Litigation

Monday, August 1, 2005 - 00:00
Steven C. Bennett

Steven C. Bennett


Recent developments have made arbitration a more popular option in disputes between institutions and individuals (such as disputes between corporations and consumers, employees and franchisees). Institutions, in particular, have become increasingly interested in pursuing arbitration in the context of disputes with individuals. Individuals and their counsel, concerned about abuse of arbitration, have increasingly sought to challenge arbitration procedures, on a variety of grounds. For institutions, the best way to obtain the benefits of arbitration, and avoid the risk of challenges to an arbitration system, is to adopt fair, neutral procedures for the arbitration system.

I. Basic Elements Of Arbitration Law

Arbitration is a creature of contract. The power of arbitrators to conduct arbitration, and the terms under which an arbitration is to be conducted, are generally governed by the agreement of the parties.

The Federal Arbitration Act ("FAA"), 9 U.S.C. §1, et seq., establishes a "liberal federal policy favoring arbitration agreements[.]" Parallel state statutes generally embody this policy as well. Under the FAA (and parallel state law), where an agreement to arbitrate exists, a lawsuit over an issue subject to arbitration may be stayed, and the parties compelled to arbitrate the dispute, rather than proceed with litigation. The results of arbitration are typically final and binding on the parties, except on limited grounds (such as "corruption" of the arbitration process).

An arbitration award, once confirmed by a court, becomes a judgment, which may be enforced in the same manner as any other judgment. An award denying relief to a claimant, moreover, will generally have res judicata and collateral estoppel effects.

II. Benefits Of Arbitration To Institutions In Disputes Between Individuals And Institutions

A. Avoiding Runaway Verdicts

Arbitration is conducted before one or more individual arbitrators, rather than by jury trial. Waiver of the right to jury trial, in favor of arbitration, is generally valid. Arbitrators may be chosen for their special expertise in an industry, or area of law. Arbitrators on standing panels may develop particular expertise as a result of repeated experience in adjudicating disputes in a particular area.

B. Avoiding Class Actions

The existence of an arbitration clause generally channels litigation away from court, and into arbitration. Thus, arbitration may effectively preclude class action in court.

Absent specific authority in the applicable arbitration clause or rules, courts generally have no authority to order consolidation of arbitration proceedings, or class-wide arbitration.

State law in certain jurisdictions permits consolidation of related arbitration proceedings. The Revised Uniform Arbitration Act, Section 10(a) also grants authority to a court to order consolidation of related arbitration proceedings. Arbitrators, moreover, generally retain authority to determine whether a specific arbitration agreement or applicable arbitration rules permit consolidation of arbitration. Institutions may also specifically provide in their rules that no class action arbitration will be permitted.

C. Avoiding Extensive Discovery

Arbitration proceedings are generally not conducted under rules similar to the Federal Rules of Civil Procedure, which provide broad devices for discovery. Arbitration proceedings are typically meant to be conducted quickly, such that drawn-out discovery proceedings are necessarily avoided, or at least limited.

Non-party discovery, although possible, may be cumbersome in arbitration. The FAA, and parallel state statutes, permit enforcement of subpoenas issued by arbitrators, but only on application to a court. The appearance of a non-party witness, moreover, is typically not for both pre-hearing deposition and at the hearing itself.

D. Limiting Remedies

Many arbitration agreements place limits on the remedies that arbitrators may award. Because the power of an arbitrator is derived from contract, these limitations on remedies will typically be effective in the context of arbitration. Limitations on awards of punitive damages may be among the most popular forms of remedy restrictions in arbitration. Other limitations, such as shortening the time to bring a claim, or "loser pays" provisions, may be included in an arbitration clause.

E. Protecting Confidentiality

Arbitration pleadings and proceedings are generally private. Arbitration awards (and settlements) are typically not publicized. Parties are free to agree (in the arbitration clause, or by choice of arbitration rules) that special confidentiality protections will apply.

F. Resolving Jurisdictional Conflicts

Arbitration agreements are a special form of forum selection clause. Instead of facing disputes about the appropriateness of one judicial forum or another, arbitration channels disputes into a single forum. Arbitration may be particularly attractive for institutions with far-flung operations (such as operations over the Internet), which could conceivably establish jurisdiction virtually anywhere in the country (or, indeed, the world).

G. Structuring According To Needs

The structure of arbitration proceedings can be substantially affected by the choices of the parties (including the specific terms of the arbitration agreement, the specific organization chosen to administer the arbitration, and the characteristics of the arbitrators). By contrast, the rules for most court proceedings, and the identities of judges and jurors chosen to resolve disputes, are largely beyond the control of the parties. Institutions that are "repeat parties" in arbitration have particular advantages, in that they can determine what is effective (or not effective) in one arbitration proceeding, and adapt their arbitration programs accordingly.

III. Disadvantages To Arbitration For Institutions

The low cost, speed and efficiency of arbitration may actually increase the willingness of claimants to pursue claims. Empirical evidence on this point is mixed. Arbitration pleading requirements are minimal. Typically, the sufficiency of an arbitration pleading is not tested by a motion to dismiss. Thus, claims that might otherwise be dismissed as legally invalid may proceed to hearing in arbitration.

Motion practice is limited. Again, because formal rules of procedure, such as the summary judgment procedure permitted under the Federal Rules of Civil Procedure, do not generally apply in arbitration, factually unsupported (or highly tenuous) claims may proceed to hearing. Limits on discovery may also sometimes work to the institution's disadvantage in this regard.

Informal hearing processes are typically followed. Arbitration agreements and rules rarely require strict adherence to rules of evidence. Thus, hearsay and other forms of suspect evidence are often admitted in arbitration proceedings. Many arbitrators will take all evidence offered "for what it's worth," placing principal emphasis on the weight of the evidence, rather than its admissibility.

Only limited rights of appeal exist. Even where an arbitrator may have committed an error of law, courts generally will not upset an arbitration award. In cases of egregious, "manifest disregard" of law, however, relief from an award may sometimes be granted.

Cumbersome procedures may disadvantage the institution when it acts as a claimant. In certain instances (such as the termination of an employee, and the attempt to ensure that the employee does not misuse trade secrets, or collection on a debt owed by a consumer) the institution may be a claimant, and may prefer the more complete processes of a court for protection of the institution's rights. Some institutions have adopted "one way" arbitration programs, giving the institution the option to pursue an action in court on its own claims, but requiring individual claimants to pursue arbitration, to the exclusion of litigation. Such "one way" programs have occasionally been criticized.

IV. Trend Toward Increasing Ability To Arbitrate Statutory Rights

Perhaps one of the largest disincentives to arbitration between institutions and individuals was the historical view that arbitrators could not resolve statutory claims. Absent the ability to ensure that arbitration would encompass all claims by individuals, institutions had limited incentives to pursue arbitration. Indeed, the use of arbitration could conceivably give an individual "two bites at the apple" in any dispute with an institution. Modern precedent has consistently favored arbitration of statutory claims.

V. Remaining Challenges To Arbitration

A. Legislative Efforts To Restrict Arbitration

The plaintiffs' bar, and others, have sought legislative solutions to perceived abuses of the arbitration system by institutions. To date, no serious efforts at wholesale reform of the FAA have been proposed, except for federal restrictions of arbitration in specific areas. Similar legislative limitations on arbitration agreements have been proposed at the state level. These initiatives, however, are potentially "preempted" by the Federal Arbitration Act.

B. Efforts To Invalidate Arbitration Agreements On Common Law Grounds

The FAA does not create a federal common law regarding the enforceability of arbitration agreements. Instead, the FAA establishes that arbitration agreements are as enforceable as any other contracts, but may be avoided "upon such grounds as exist at law or in equity for the revocation of any contract."

Grounds for revocation of arbitration agreements, as other matters of contract, are generally governed by individual state law. What the FAA makes clear is that the grounds must be of general application; a state may not have one rule for the validity of contracts in general and another rule for the validity of arbitration agreements.

C. Separability Hurdle

A contract containing an arbitration agreement is viewed as actually two contracts; the main contract and the contract to arbitrate. The general allegation that the contract is void (on fraud or other grounds) may itself be a subject for arbitration. Due to the "separability" doctrine, it may be difficult to avoid arbitration merely by claiming that a contract containing an arbitration clause is void. Any claim regarding the invalidity of the contract must be directed at the arbitration clause itself.

D. Unconscionability Grounds For Challenging Arbitration Agreements

Unconscionability is a state law concept, derived from general principles of contract law. The precise law of unconscionability varies from state to state. The mere fact that the individual must "take it or leave it" with regard to a contract does not automatically invalidate the contract. The individual typically has at least the "leave it" choice in responding to the proffered contract.

Where both procedural and substantive unconscionability appears, an arbitration clause may be invalidated. Proof of procedural unconscionability may include indications that the individual did not have a meaningful choice, such as: (i) lack of experience and education of the party claiming unconscionability; (ii) whether the contract contained "fine print"; or (iii) "high-pressured tactics" and any disparity in the bargaining power of the parties. Proof of substantive unconscionability may include indications that the terms of the agreement unreasonably favor one party over another.

E. Particular Substantive Grounds For Challenging Arbitration Agreements

Prohibitive fees: Where the fees for filing or pursuing arbitration are prohibitively high for the individual, an arbitration clause may be held unconscionable. The mere fact that an arbitration agreement is silent as to who pays the cost of arbitration, however, does not automatically invalidate the agreement.

Biased panel: Where the institution adopts a procedure for selection of arbitrators that may result in biased decision-making, the arbitration provision may be challenged.

Inaccessible location: An arbitration clause specifying a location for arbitration that is at great distance from the individual may be invalidated.

Restriction of statutory rights: Although the mere fact that statutory rights are involved will not generally invalidate arbitration, express restrictions on statutory rights may be grounds for challenge of an arbitration provision.

Lack of mutuality: Some courts have held that, where an arbitration clause provides the exclusive remedy for the individual, but not the institution, the clause lacks "mutuality" and may be unconscionable.

F. Making Of Agreement Also Subject To Challenge

The FAA and parallel state statutes generally require a written agreement to arbitrate. The arbitration agreement need not have been signed by the individual resisting arbitration, so long as there is evidence of an agreement to arbitrate.

Difficult circumstances may arise where it is unclear whether the individual knew of, and consented to, the arbitration provision. Thus, for example, with "shrink wrap" agreements (which become effective based on a consumer's use of a product) or "click-wrap" agreements (which become effective based on a consumer's on-line activity), challenges may be mounted premised on the consumer's lack of awareness and consent. Similarly, arbitration provisions in an employee handbook may not be effective, where the employer disclaims an intent that the handbook constitute an employment contract. See Editorial, page 14, for summary, Maximizing The Effectiveness Of Arbitation.

Steven C. Bennett is a Partner in the New York City offices of Jones Day, and teaches Arbitration Law at Brooklyn Law School. He is the author of Arbitration: Essential Concepts (ALM 2002). The views expressed are solely those of the author, and should not be attributed to the author's firm, or its clients. The author wishes to acknowledge the research assistance of Steven G. Gyeszly, an Associate in the Houston Jones Day offices.

Please email the author at with questions about this article.