18 Jun But Before You Add That Arbitration Clause…

Last week we discussed adding an arbitration clause to your company’s business contracts with clients and business affiliates.  Alternative dispute resolution options like arbitration or mediation are always more cost-effective than engaging in protracted litigation, which could carry a price tag as high as $91,000.

However, in order for arbitration to be cost-effective, your business must ensure the arbitration provision is written properly.  Using a generically-drafted arbitration clause can ultimately result in additional problems and costs to the parties in the contract.  The arbitration, to be cost-effective, must be tailored to the particular contract at issue, the particular transaction at issue, and according to the relationship of the parties.

Include These Details in Your Arbitration Clause

Here are key areas that should be considered, and if applicable, included in your arbitration clause:

• Mediation or Other Prerequisites to Arbitration. Will the parties have certain requirements to meet prior to engaging in arbitration?  Your company might consider requiring the parties to mediate prior to initiating an arbitration, since mediation is likely a more cost-effective dispute resolution option to arbitration.  If mediation is required, this provision will need to detail where the mediation is to take place, and whether a particular party/organization will serve as the mediator, such as JAMS.  Lastly, this provision should include details about how the parties will split mediation costs.

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• Scope. Consider what types of claims your company would need to arbitrate.  Are there any claims that your company would want to exempt from arbitration?  Use the arbitration clause to spell out which claims will and will not be arbitrated.  For example, if there are any claims that might require your company to obtain a temporary restraining order to stop bad activity, like noncompete or nondisclosure/trade secret violations, your company may want to consider excluding these claims from arbitration, in order to allow your business to take immediate action with the courts.

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• Prevailing Party Attorney Fees. Your company will always want to include a prevailing party or fee-shifting provision in its arbitration clause.  Such a provision allows your business to recover its attorney fees and costs from a favorable arbitration.  A solid prevailing party provision will look something like this:

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Attorney Fees. In the event that any dispute between the Parties should result in arbitration, the prevailing party in such dispute shall be entitled to recover from the other party all reasonable fees, costs and expenses of enforcing any right of the prevailing party, including without limitation, reasonable attorney’s fees and expenses, all of which shall be deemed to have accrued upon the commencement of such arbitration and shall be paid, whether or not such arbitration is completed to order or judgment.  The prevailing party is also entitled to the recovery of attorney fees and costs incurred in enforcing such arbitration order or judgment, as well as an award of prejudgment interest from the date of the breach, at the maximum rate allowed by law.  For the purpose of this Section, prevailing party shall mean the party who is determined in the arbitration to have prevailed or who prevails by dismissal or default.

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• Location, Rules and Governing Law.  It is critical that your business lay out not only the location where the arbitration must take place, but also the rules and governing law that should apply to an arbitration between the parties.  Often AAA (American Arbitration Association) rules are used, but you or your attorney must review these rules to ensure they make sense for your business.  Moreover, this section of your arbitration provision must set forth which state’s laws will govern the arbitration.  Your business must then decide whether the laws of your business’s state of incorporation will govern, or, if different, the laws of the state where it has its principal place of business.  While your company’s arbitration hearing is confidential in that the general public is not allowed in the hearing room, this does not stop a party to the arbitration from disclosing the details or contents of the arbitration to a third party.  Thus your company’s arbitration provision must contain very specific details about the parties’ obligation to keep the contents of the arbitration confidential, with limited exceptions to that rule (e.g., court order or subpoena).  

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• Fee Splitting. Similar to the fee-shifting provision discussed above, the parties can and should include in the arbitration clause details about how the arbitration will be funded.  Will the disputing party or both parties pay for the arbitration?  If the fees are to be split, how will they be split, 50/50?  It is also necessary to include details on how to handle a situation where one party refuses to pay or stops paying before the arbitration is completed.

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• Who Will Be the Arbitrator/s. One of the key benefits to arbitration, besides the cost savings, is the parties’ ability to choose who the arbitrator will be for the arbitration, and if necessary whether three arbitrators should be used to resolve the dispute.  Your business will need to determine whether it should rely on the judgment/expertise of one arbitrator or whether three arbitrators should be used with varying degrees of knowledge.  If there is a particular issue that is regularly in dispute with parties to your contract, you may want to consider including a list of arbitrators in the contract, and ensuring the other party is aware of this limitation prior to signing the agreement.  If a list will not be included, this provision must detail how the parties will choose the arbitrator, and whether the chosen arbitrator must have a particular skillset or other particular qualifications.

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• Limit on Damages. Your company may want to exclude the arbitrator from ruling on certain types of damages that are hard to ascertain like consequential damages, or have the potential to be exorbitant such as punitive damages.  Those types of damages may even be excluded from the contract altogether, to support the arbitration limit.

If your company needs assistance in drafting or revising a new arbitration provision, call Edwards Law today for a complimentary review of your business contract.  It will save your company money and reduce stress in the long run.