APU Business Careers Careers & Learning Original

Why Corporations Prefer Arbitration to Litigation (Part III)

By Dr. Gary Deel, Ph.D., J.D.
Faculty Director, School of Business, American Public University

This is the third of three articles examining the legal concept of arbitration.

In the first article, we discussed the concept of arbitration and its various forms. In Part II, we examined the steps involved in a typical arbitration proceeding and some of the caveats that go along with selecting arbitration for dispute resolution.

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Now, let’s see why, in spite of all its drawbacks, arbitration is still the preferred method of dispute resolution for most of corporate America.

Six Reasons Arbitration Is Popular in Dispute Resolution

First, unlike litigation in court where all filings and proceedings are public, arbitration is generally a private process. Parties are usually bound to confidentiality concerning the proceedings, arguments, admissions and awards, unless all unanimously consent to public disclosure.

This is valuable to large companies that have a lot to lose in terms of damage to their reputation and public image were they to air their dirty laundry in a public court. Also, by keeping any settlement agreements private, companies avoid public award disclosures that could incentivize other potential litigants to sue.

Second, arbitration is usually faster than litigated cases. Court cases can take months or years to reach closure, depending on the length of discovery, pre-trial motions, trial procedures, and other delays. Arbitration, by comparison, is a much more streamlined and expedient process.

Third, in some cases arbitration decisions can be held to the status of precedent for the purposes of navigating future disputes of a similar nature. In this sense, arbitration can still provide the kind of weight and authority needed to address class action claims but without the costs and time investment of formal litigation.

Fourth, the lack of appellate review (discussed in Part II) serves as a double-edged sword. Although businesses can’t appeal decisions they don’t like, their opponents can’t appeal either, which means litigants can’t tie up companies in court for years of certiorari (review).

Fifth, in most arbitration cases disputants may decide collectively on an arbitrator and on a choice of law to be applicable. This means they can choose where the arbitration hearings are held and which jurisdictions laws are applied in analyzing the dispute.

Large companies often use their size and power to give themselves a “home court advantage” by stipulating the venue and choice of law for future claims. This is typically not an option in litigation when lawsuits are assigned to judges on a rotation basis. The judges will then apply the law of the jurisdiction where they reside, absent any prior agreements to the contrary.

The sixth and final reason for corporations’ preference for arbitration is cost savings. Historically, the litigation process has been used to resolve business and employee complaints, but this can have a costly financial impact on an organization’s bottom line. There are generally two models for legal costs in litigation: the English Rule and the American Rule.

The ‘English Rule’ Provides that the Losing Party in Litigation Pays All Legal Costs

The “English Rule” provides that the losing party in litigation shall pay all legal costs of the prevailing party. The rationale for the English Rule is that the person who wins the dispute should not be financially burdened in any way for having had to prove his or her righteousness.

The ‘American Rule’ Provides that All Parties in Litigation Pay Their Own Legal Costs

The “American Rule,” on the other hand, provides that parties to litigation are responsible for their own costs, notwithstanding the outcome of a suit. The rationale for the American Rule is that burdening potential litigants with the risk of being responsible for the legal costs of both parties unfairly discourages litigation. In other words, it might intimidate parties into not pursuing otherwise meritorious claims for fear of being financially crippled if they lose.

While the American Rule is the default standard in the United States, it can be preempted by specific statutory provision. For example, civil procedure rules in some states hold that a litigant who declines a pre-trial settlement offer, and then subsequently loses, shall be responsible for the opposing party’s fees. The American Rule can also be modified by agreement between parties; signatories to a contract may stipulate in advance how and by whom legal fees are to be paid in the event of a dispute.

Barring these kinds of special exceptions, however, the American Rule applies. And the costs associated with litigation (attorney fees, court fees, expert witness fees, investigative fees and other costs) can be so expensive that many large businesses are inclined to settle cases outside the formal court system, even if they end up paying out on a matter for which they might not have otherwise been found responsible in a court of law.

Again, the American Rule means that parties must do the hard math and determine whether their legal costs to win a court case would surpass the cost of simply settling the case out of court. In the end, many organizations opt for arbitration to resolve complaints and mitigate the negative impact that formal litigation would otherwise have.

Major Industries Have Mandatory Arbitration Clauses in Their Consumer Agreements

Recognizing the benefits of arbitration, many major industries have incorporated mandatory arbitration clauses in their standard consumer agreements. They include credit card companies and banks, automobile and consumer goods manufacturers, and tech giants.

Most large companies impose binding arbitration through what are called “adhesion contracts,” whereby one party disproportionately controls the nature of the agreement terms. Adhesion contracts are commonly used between large commercial entities and their consumers and employees.

Consider, for example, the agreement you have with your cell phone provider. I would be willing to be that that somewhere, buried in the fine print of your contract (which you didn’t read when you signed it), is a mandatory binding arbitration clause. That clause states, in short, that if a dispute arises between you and your cell phone company, you agree to submit that dispute to binding arbitration.

Now it could be argued that you had a choice not to enter into that agreement at all. But because you chose to enter into it freely, you should be held accountable for all the commitments you made therein. However, the lack of bargaining power on your side makes these types of agreements very suspect.

After all, it’s not as if Verizon will negotiate with you on the terms of its arbitration clause. If you don’t like the Verizon contract, you can go down the street to Sprint or T-Mobile, where you’ll find the same non-negotiable arbitration clauses.

Although adhesion contracts are not illegal per se, courts will closely scrutinize their terms and clauses under the doctrine of reasonable expectations, and strike any provisions that violate this rule. Thus, the legality of a contractual obligation to arbitrate will usually rest on whether the relevant court would find such an obligation to be reasonably expected by both parties.

Formal Arbitration Is Still a Binding Form of Dispute Resolution

But formal arbitration is still a binding form of dispute resolution. And because many of today’s complex arbitration proceedings are such that disputants benefit significantly from the specialized (and very expensive) skills of legal counsel, large companies use arbitration to reduce their risk without sacrificing leverage. This has resulted in a modern arbitration paradigm that protects big business from the formal litigation system. But it arguably disadvantages individual consumers, the proverbial “little guys,” in the process.

So the next time you hear about a major arbitration case being argued, be sure to consider the factors that drove both parties to compel arbitration.

About the Author 

Dr. Gary Deel is a Faculty Director with the School of Business at American Public University. He holds a J.D. in Law and a Ph.D. in Hospitality/Business Management. He teaches human resources and employment law classes for American Public University, the University of Central Florida, Colorado State University and others.

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