Is Arbitration Really In Your Best Interests?
Since I became a lawyer in 1989, the use of arbitration as a dispute resolution technique has skyrocketed, and it is increasingly rare these days to find a contract that does not have an arbitration clause. Indeed, arbitration has become something akin to a legal panacea, and not without good reason because of the advantages of arbitration. These advantages may be defined by two primary benefits: Faster resolution and reduced costs.
Arbitration results are much more quickly obtained than courtroom litigation, since discovery rights are tightly constricted, trials are much shorter, and there is no often no right to an appeal. One may expect to walk away with a judgment from an arbitration in about six months, whereas a civil case that goes to a jury will usually take around two years from the date the complaint is filed, and can stretch longer than five years where there is an appeal. This quickness keeps the dispute from hanging over everybody's heads, and thus perhaps affecting other business decisions, for the long periods of time that would normally play out in courtroom litigation.
Arbitration costs, expenses, and attorney's fees are usually much lower than in courtroom litigation for the same reasons, i.e., the less for attorneys to do, the smaller their billings.
Those are the primary benefits of arbitration, but there can be others of greater or lesser importance depending upon the particular matter. For instance, since arbitration is private, the airing of one's dirty laundry in a public courtroom can be avoided. It can also be very difficult, although not completely impossible, for a party to bring class-action litigation where arbitration has been mandated.
These benefits of arbitration, all of which have been completely validated over the years, is why arbitration has become such a popular alternative to courtroom litigation. Tellingly, companies continue to use arbitration even though there are some studies which suggest that in consumer cases, just for instance, companies are more likely to lose in arbitration than in ordinary courtroom litigation. The reason that these companies still choose arbitration is that in the long run, they still save more money through the fee-savings of arbitration despite losing more cases than they would have expended in courtroom proceedings even if they had won more cases there.
So, with all these benefits, why wouldn't somebody choose arbitration if they had a choice? The answer is that there is no free lunch, and the benefits of arbitration come with a hidden cost. With arbitration, the hidden cost is that the quality of results is often quite poor.
There are at least two reasons for the quality of arbitration decisions being poor. The first reason is that all those things that arbitration eliminates for cost-savings, such as broad discovery and a right to an appeal, are designed for the very purpose of giving the court the best chance of making the correct decision. All of these safeguards go out the window with arbitration. If a party could not obtain a key piece of evidence because they had no discovery right to obtain it, too bad. If an arbitrator makes an incorrect ruling on some important question of law, too bad. You have to live with the results nonetheless as the price of being cheap.
The second reason will be more contentious, and is largely proffered on the basis of my own anecdotal experience, being that the quality of arbitrators is generally a lot lower than folks would generally like to believe.
Now, somebody will likely point out to the effect that, "Hold on, most arbitrators are coming off the bench, and these are the same folks who would decide the case in courtroom litigation." In the abstract that is sort of true, but it does not reflect certain realities. For instance, judges are typically restricted to ruling on issues of law only, and issues of fact are left to the jury. This creates a firewall between the finder of fact and the finder of law so that there is not a fudging of either the law or facts to facilitate a lazy ― and then often incorrect ― resolution of the matter.
The most important substantive difference between arbitration and courtroom litigation is that the court process allows for an appeal, whereas arbitration usually does not. There is a reason that our system of civil justice has full-time courts of appeals: Judges frequently make mistakes. Now, not all mistakes are material or outcome-determinative, but enough mistakes on important issues of law occur that our appellate courts are daily churning out opinions which fix these mistakes, and there is an entire bar of appellate lawyers who do little more than appear before those courts. If a judge makes a serious error in courtroom litigation, it is highly probable that the court of appeals will correct that error. Contrast that with arbitration: If the arbitrator really flubs an issue badly, the losing litigant probably has no or little recourse.
As mentioned, the quality of arbitrators in general is not very good, and, frankly, many arbitrators are in fact quite poor at what they do. The problem arises from the fact that most arbitrators are former judges, but anecdotally (to this litigator) the quality of judges has been in serious decline in recent years. The problem is with the pay scales of judges: Judges today are paid only a poor fraction of what top lawyers make, and so therefore there is a strong financial incentive for the best lawyers to avoid the bench.
Now, to be fair, there are a lot of very good judges out there who take the bench for reasons other than money, such as their higher concerns for the health of our justice system or because of personal factors, such as they had a close relative who took the bench. Take the bench can also be an honor, as in the case of federal judges who are confirmed by the U.S. Senate. Unfortunately, as our nation's judicial benches grow to handle increasing volumes of litigation, such judges have become a smaller percentage of the overall whole. Notably, they are also the type of judges who will stay on the bench until retirement, often continuing past that mark as senior judges, and never end up as arbitrators.
Today, the judges who end up as arbitrators are all too often those who come from the lower end of the legal quality scale. Far too many arbitrators are lawyers who were failures as lawyers and thus sought the steady salary of being a judge, took the bench and were failures as judges, and then left the bench to become arbitrators. In this latter role, their shortcomings could be hidden by the fact that their outcomes were not subject to appellate review. Only over time and by passage of word to mouth does it get out in the local legal community that somebody is also a failure as an arbitrator, and by that time they may have left a lengthy carnage of bad decisions.
Indeed, it has become a common occurrence for lawyers to seek an appointment or election to a single term on the bench just to become an arbitrator, because such work is viewed as "low energy, high fee" work. Some of these arbitrators are pretty good, but the majority are not. Again, most were not good lawyers to begin with, and what little time they spent on the bench did not significantly improve their judicial skills.
There are certainly good arbitrators out there, but they tend to be hard to find. My preference in choosing an arbitrator is always for either federal judges or quality still-practicing lawyers (to the extent they are even available for arbitration), with former state court judges or full-time lawyer-arbitrators falling towards the bottom of the list.
An additional problem with arbitration is so called "big firm bias". Arbitrators make their money by being referred cases to arbitrate, and big law firms typically send arbitrators more business if they perceive that they get more favorable decisions from an arbitrator (or arbitration firm). Thus, arbitrators have a built-in conflict of interest in that it is better for their own bottom line to lean in their results towards the firms that are sending them the most business. A sole practitioner or small firm may never appear before that arbitrator again, so if the arbitration decision doesn't favor them, well who really cares if they are upset by a decision? Most arbitrators, thankfully, don't even think of this and put it behind them, but not just a few take it into account ― consciously or subconsciously ― when writing up their final results.
The bottom line is that the quality of arbitrators is generally not good, to be kind, and this ― combined with the lack of discovery and appeal rights ― means that the quality of results one can expect in arbitration is often much less predictable than one might find in courtroom proceedings. Goodness knows that there are a lot of folks who may disagree with this conclusion, but, again, that is my anecdotal perception based on my own experiences and those of other lawyers that I converse with.
Does this mean that arbitration should invariably be avoided? Not at all, but rather that the benefits and limitations of arbitration have to be understood for particular parties in particular circumstances.
If you are a major corporation, say Amazon that potentially faces many thousands of consumer lawsuits per year, you are still going to chose arbitration even if consumers end up winning more than they should. The reason that you would do so is that even if you end up paying more in arbitration award to consumers than you might had the matter gone through courtroom litigation, you still come out ahead because over all those thousands of cases you are still going to save money in legal fees. If you are Amazon, you really don't care if Consumer A got paid more than they should in one case because the arbitrator there was a total incompetent, what you really care about is the aggregate amount that you paid out for all the thousands of claims over a period of time for both the awards and the legal fees ― and in the aggregate Amazon will come out ahead arbitrating all those cases instead of litigating them in the courts.
Which is to say that Amazon can suffer an adverse result on any given case and not really care because it is a big company and can spread the effects out over thousands of such cases. This of course implicates the Law of Large Numbers that is used so much in the insurance and gaming businesses: If you flip a coin three times, you might get three heads or three tails or any combination of results, but if you flip a coin a thousand times then the distribution is going to be pretty close to 50% heads and 50% tails. Arbitration results are pretty much the same: In a single given case, who knows what the outcome might be, but over a thousand cases you're probably going to win about half and lose about half, and the only thing that you really care about is getting those cases over quickly so that your legal fees are as low as possible.
Again, Amazon can lose one case and not worry about it because it is a large company with a huge balance sheet. But not everybody is Amazon.
The problem with arbitration arises with smaller businesses and individuals in larger cases, meaning cases where an adverse outcome can be financially ruinous to them. Smaller businesses and individuals do not have a huge balance sheet that will allow them to absorb a large adverse result, and they don't have thousands of other cases where they can take advantage of the Law of Large Numbers. These are, quite literally, life or death cases for the involved small business or individual and they desperately need the tribunal to get the result exactly right. They are therefore much better off eschewing the cost-savings of arbitration and instead going the route of traditional courtroom litigation with all of its built-in safeguards, such as broad discovery and appeal rights, to give those litigants the best chance of the right result.
That then defines the limits of when arbitration should be selected: If the potential award is large, relative to the small business or individual, then they should avoid entering into arbitration agreements for that subject matter.
This is easily said in the abstract, but the problem is that there has in recent years such a belief that arbitration is a panacea for everybody that arbitration clauses are often adopted in agreements with little consideration to whether such clauses are a good idea under the circumstances. Since nobody entering into a deal expects them to go bad (else presumably they wouldn't get into the deal in the first place), the language found in agreements as to what actually happens if the deal goes sour is all too often relegated to that boilerplate section which everybody skips over, and that boilerplate section these days typically includes an arbitration clause.
Which is all to say that the drafters of agreements should quit treating arbitration clauses as being invariably good for the party they are representing, and instead have a long and hard talk about whether arbitration or ordinary courtroom litigation would be preferable. These discussions are not, unfortunately, happening enough.
The analysis here is simple in theory: If the matter is relatively unimportant in the bigger scheme of things, then you want to go to arbitration and save money on legal fees. If the matter is important and you need to have the best chances of getting the correct result, then you will want to avoid arbitration and go the normal courtroom litigation route. If there is substantial doubt as to which path is better, go with the latter: Go to court.
Note that it is quite possible to make arbitration proceedings better by drafting additional provisions to make it more likely to reach the correct result. For instance, if the amount in controversy exceeds some level, say $500,000 or something, then the arbitration agreement can be drafted so that the parties have the same discovery rights that they would have in ordinary courtroom litigation, the arbitration will be done by a panel of three arbitrators instead of just a single arbitrator, and the parties will have a right to appeal an issue of law to yet another arbitrator ― albeit, on this point the party seeking the appeal will have to advance all the legal fees for both parties (i.e., including the adverse party) so as to discourage all by the most serious appeals. All of this will, of course, increase the costs of the arbitration and slightly increase the fees incurred by both parties in the expanded discovery, but the chances of getting a better decision are worth it.
Again, the bigger point is that folks should be thinking of all these things and not just presume that arbitration is invariably in their best interests, because it isn't. Planners who are drafting agreements should similarly be talking with their clients about whether to include (or agree to) arbitration clauses, but largely those conversations are not happening.
Have those conversations, please.