Contract Arbitration: 3 Advantages and 3 Disadvantages for Your Business

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When a contract breaches and a relationship goes sour, contract arbitration is a common way to settle the parties’ differences without going to court. Arbitration can save both parties a heap of money, and potentially other costs like a messy, public court battle. It sounds good, right? And it is an option but there are a few pitfalls. Read on.

What is Contract Arbitration?

Arbitration is a process whereby the parties agree to allow a third party – or arbiter – to decide their fate in the case of a disagreement such as a contract breach.

Its better-known cousin mediation is different because the mediator doesn’t have binding authority so needs to find a compromise. Arbiters frequently look for compromises but in the end, what they say goes. They have the power to make a decision that all parties are beholden to.

As a consumer, you’ll frequently find arbitration clauses in service-level agreements like phone and credit card contracts, and employment contracts. It’s common in small business contracts with suppliers and service clients. The clause could be as simple as:

Arbitration. All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of Florida or another location mutually agreeable to the parties. An award of arbitration may be confirmed in a court of competent jurisdiction.

Source: NOLO

Or it could go on to specify the name or firm of the chosen arbiter, their scope for decision-making, and how the process should be funded. 

Contract Arbitration Advantages

Whether you’re drawing up the contract or redlining someone else’s, there are some benefits to considering an arbitration clause.

1. Reliable and Lower Litigation Costs

Arbiters usually cost between $1000-$2000 a day and the whole process usually costs less than $10,000.

That seems like a lot until you compare it with the cost of going to court. A 2013 investigation by the National Center for State Courts [PDF] into civil lawsuits involving a car found that a case that settles after discovery – that is, an undisputed settlement – will cost one party $5,000-$26,000. If that case goes to trial, both sides are up for closer to $18,000 to $109,000. At that point, you have to ask yourself: How much was the contract worth anyway?

2. Faster Resolutions with Less Impact on Your Business

With an arbiter, you also generally know how long it will take to get a result [PDF]. By contrast, a trial can drag on for weeks or months, and appeals can derail you even if you thought the original case was resolved.

3. Arbitration is Generally Private

Relationships are the bedrock of all small businesses. When contracts go south, relationships turn sour. What was once a private email chain written in good faith is now evidence being used by your opponent. That’s bad enough but the closed-doors nature of arbitration means you don’t have to air your corporate dirty laundry in the way you might in a high-profile trial. Keeping a lid on arbitration proceedings has benefits for your brand as well as other business relationships.

Disadvantages of Contract Arbitration

There are some circumstances, however, where arbitration will fail to serve you. And more cases still where it won’t serve any of the parties!

1. You Have Fewer Rights in Arbitration

As messy and expensive as it is, the right to civil litigation is an important one in our system. It’s one of the few ways we can get redress when a business fails us. In arbitration, you’re essentially relinquishing your power to sue. While the arbiter will hopefully make a fair decision, you’re generally unable to appeal. The swiftness and clarity that is a strong benefit of arbitration also means fewer options for the injured party.

2. It’s All or Nothing – You Can’t Choose When to Arbitrate

Once a contract arbitration clause is signed into the contract, the parties are bound to this process. You’ve effectively agreed to give up control before you discover there’s a problem. And that can be frustrating when you think there’s a simpler way to deal with a small infraction, or when you have a watertight case and you want to go in all guns blazing.

3. Your Arbiter Mileage May Vary

Finally, there’s no gold standard for arbiters or the arbitration process, so what they do and how they do it varies widely. If you’re using a simple arbitration clause, similar to the one above, you could be assigned someone you don’t trust or who has a conflict of interest in your case. Likewise, you could wind up with someone who knows nothing about the complexities of your business. We recommend you add clause language about what you require in an arbiter, their qualifications, firm, expertise, and relationship (or lack thereof) to the parties.

How to Prepare Your Business for Contract Arbitration

The best way to avoid arbitration, of course, is to avoid breaching a contract. Having a contract lifecycle management system will help you stay organized and on top of what your company has promised and how it will deliver it.

If you do need to go to arbitration, however, your business will be at an advantage if it’s organized. How easy would it be for you to pull all correspondence relating to a breached contract including redlining and review, as well as fulfilment data from your ERP?

If your blood pressure just spiked, you should look at a contract lifecycle management platform like Anapact. Whether you’re prepping for contract arbitration or just trying to get everyday work done more efficiently, Anapact streamlines every part of the contract process. Get a demo today.

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- About the Author

Picture of Louis Balla
Louis Balla
Louis is the Co-Founder of Anapact and partner at Nuage, a top rated ERP consulting firm based in Venice Beach, California.