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Arbitration Falling Out of Vogue (Lawyers USA)

March 10, 2008

By: Sylvia Hsieh

After years of making mandatory pre-dispute arbitration a boilerplate provision in all contracts, companies are now rethinking the use of mandatory arbitration in business-to-business, consumer class action and employment cases.

The increase in discovery, motions and appeals in arbitration practice has caused arbitration to lose its main attractions – speed, cost and finality.

As a result, a growing number of companies are calling into question whether arbitration is the most cost-effective way to resolve disputes.

"Corporate counsel are looking at arbitration clauses with more suspicion than they did previously," said Joseph Wargo, a commercial litigator and partner at Wargo & French in Atlanta.

"I have a sense that quite a number of companies and entities have found arbitration to be a disappointment," said Greg Curtner, a litigator who handles high-end corporate disputes and practices in California, Michigan and New York. "Either they have modified their approach to it or have gone away from it entirely."

The main reason for the dissatisfaction is "the reality that arbitration is becoming more and more like litigation," said Thomas Stipanowich, a law professor at Pepperdine Law School in Malibu,Calif., and an expert on arbitration.

At the recent annual meeting of the International Institute for Conflict Prevention and Resolution, one member complained that "trial lawyers have hijacked arbitration."

Many law firms got into the arbitration business as the industry expanded and have influenced the way arbitration has developed.

"You get a lot of lawyers who say arbitration is just like litigation, but instead of doing it in front of a judge, you're in front of three arbitrators," said Helena Tavares Erickson, senior vice president of the Institute. "If lawyers on both sides think that way, what is their incentive to streamline the process?"

'Lesser of two evils'

Charles Morgan, former general counsel of BellSouth and currently managing director of FTI Consulting, said that "most general counsel today would tell you arbitration is the lesser of two evils – not as bad as litigation, but still pretty unsatisfactory."

The increase in procedures is one unwelcome change.

For example, the Federal Arbitration Act is much longer than it used to be and now addresses supervised discovery, said Stipanowich.

Additionally, the American Arbitration Association has adopted its own rules that "make companies jump through more hoops in order to get a resolution," particularly in consumer class action and employment proceedings, said Wargo.

The proliferation of motions practice – particularly over whether an arbitration clause should apply – also drives up costs.

Others complain that because arbitrators are paid by the hour, they are not inclined to resolve disputes quickly.

"Sometimes you get a panel of three arbitrators and they don't have a whole lot else to do and they're getting paid a pretty good hourly rate. They'll ask both sides to waive the time limit, and then it's off to the races," said Curtner.

Some lawyers say the quality of arbitrators is going downhill.

"Frankly, it's becoming harder and harder to get qualified arbitrators to handle disputes. Anybody can hang out a shingle," said Wargo. He prefers using a lawyer in the community as an arbitrator even if he has to forego a panel of arbitrators, because "I know what I'm getting."

The finality of arbitration has been much-lauded, but the notion that arbitration awards are ironclad and can't be undone is no longer the case.

In some states, like California and New York, parties have a greater chance of getting an award overturned, said Stipanowich.

In fact, a "minor cottage industry had developed in looking for conflicts of interest as grounds for overturning an arbitrator's award," he said.

Court action

Court rulings have had an effect on the arbitration landscape.

For example, the U.S. Supreme Court will decide this term whether the Federal Arbitration Act supersedes parties' ability to select standards for reviewing arbitration awards. (Hall Street Associates v. Mattel, No. 06-989.)

In California, a ruling by the state supreme court in 2000 "changed the landscape significantly" in the way companies approach arbitration in the employment context, said Douglas Farmer, a labor and employment attorney and managing shareholder of the San Francisco office of Ogletree Deakins.

The court said that employers must pick up the cost of arbitration beyond what the employee would have paid in court, regardless of the outcome. (Armendarez v. Foundation Health Psychare Services, Inc., 24 Cal. 4th 83).

Employees are also entitled to conduct "reasonable discovery" in arbitration, which can increase the cost, and it is no longer legal in California to exclude punitives from an arbitration damages award, Farmer said.

"What that has done is made employers think very carefully about imposing mandatory arbitration on employees," he said.

The two main considerations in deciding whether to put arbitration clauses in employment contracts are jurisdiction and type of claims.

Employers in plaintiff-friendly jurisdictions may choose the cost of arbitration over rolling the dice with a jury.

But "if you do business in a jurisdiction where cases are routinely resolved in favor of the employer, you would perhaps be better off from a financial perspective going forward with a case in court," said Farmer.

And employers should look at the types of claims they have defended in the past as a predictor of future claims to decide whether they should continue to use mandatory arbitration.

"If your company experienced many discrimination claims against it, you need to strongly consider an arbitration program, because those claims if brought before a jury could be devastating to your company," Farmer said.

Customizing the arbitration clause

Although not many companies are removing existing arbitration clauses, many companies are leaving them out when they rewrite their contracts, said Wargo.

Others are customizing their arbitration provisions to make them more streamlined, said Erickson.

Rather than using boilerplate arbitration clauses, companies are more frequently drafting their own provisions.

"The parties are being very proactive. They are writing in how they want the arbitration to proceed," Erickson said.

A typical provision will preclude discovery unless there's a showing of "substantial need," she said. Another common clause requires the arbitrator to make a decision for one side or the other.

This addresses the frustration that "sometimes you get arbitrators who don't understand the issue or don't want to take a stand on it, so they do the proverbial 'splitting of the baby,'" said Curtner.

More companies are also requiring an arbitration award that is not "reasoned," especially in highstakes areas like patent law, said Erickson.

Without a written decision or reason for the award, a showing of "manifest disregard of the law" on appeal would be much harder to make, even though such appeals have become "routine" in the past few years, she said.

Another reason for this provision is to save money.

"Think about the time and cost for three people to get together and write a decision," noted Erickson.

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